Individuals possessing a United States (“US”) permanent resident card (commonly referred to as a “green card”) obtain several privileges and advantages. From an immigration standpoint, they are allowed to reside in the US. Further, their employment is not limited to any particular employer, as is commonly the case with many work visas. From an income tax perspective, they become “US persons” and, prima facie, “US residents” under the US Internal Revenue Code (the “Code”). As a result, they become subject to US federal taxation on their worldwide income. From a US gift and estate tax perspective, their green card increases the risks that the IRS may treat them as domiciles (and hence US gift and estate tax residents) of the US, which makes them subject to transfer taxes on their worldwide assets.
Conversely, when an individual surrenders their green card, whether voluntary or involuntary, it can have both beneficial and adverse US income tax consequences. This article addresses some of those consequences and provides some planning suggestions for alleviating some of the negative consequences.
Surrender of a Green Card
The same income tax consequences would arise whether the surrender is voluntary or involuntary. A “voluntary surrender” would involve the individual voluntarily handing in the green card at a US embassy, consulate, or border crossing, and signing a Form I-407, “Record of Abandonment of Lawful Permanent Resident Status”.
An “involuntary surrender” would arise where a US border officer determines that the individual has forfeited his or her right to keep the green card. Such a determination can arise where the individual has spent significant time outside the US, without a valid returning residency permit at which time the border officer may determine that such activity has violated one of the conditions of the green card, namely that the individual permanently resides in the US. Consequently, many individuals who have relocated to another country (for example, for work related purposes) and have not obtained a returning residency permit (which would allow them to live abroad without jeopardizing their green card) are at risk of having their green card seized at a US border crossing.[1]
It should be noted that, from a tax perspective, the individual still maintains his or her green card status until they sign the Form I-407, or have a tribunal rule on their loss of status. One common misnomer is that one loses their green card status by letting their card “expire” (i.e., reach the expiry date written on the card and not renewing it). A card’s expiry date does not sever the individual’s status, it merely imposes an obligation to renew the card. Another misnomer is that green card holders who have left the US years ago have effectively ceased to be permanent residents for tax purposes. While they may be vulnerable to having the card seized at the border, until this happens, they still are considered permanent residents for income tax purposes.
Finally, it is possible for an individual to obtain a partial relief from the typical income tax obligations imposed on green card holders by filing a non-resident income tax return (Form 1040NR) as a result of having closer ties to another country with which the US has an income tax treaty. Such a “hybrid” non-resident would be considered a non-resident for tax liability purposes - that is, they would only report, on their tax return the types of US source income that a typical non-resident would. On the other hand, they are still considered “US persons” under the Code and would still have the same obligations to file information returns such as a Form FinCen 114, also known as the “FBAR” (to disclose their non-US bank and brokerage accounts), Form 3520 or 3520-A (to disclose interests in foreign trusts), or Form 5471 (to disclose interests in foreign corporations). Note that such a hybrid filing does not of itself sever the individual’s green card status for all future taxation years;[2] it only affects the particular taxation year in question. While the individual still retains the green card, they will still have to file as residents (or hybrid non-residents) in future years.
Non-Expatriation Tax Consequences of Surrendering a Green Card
If the individual surrenders his or her green card, they will typically[3] become non-residents from a US federal[4] income tax perspective. In the year they surrender their green card, their last day as US income tax residents will presumed to be December 31 of the year of the surrender (in which case they will continue to file a full year resident return for that year), or an earlier date in that year if they can demonstrate a closer connection to another country as of such date (in which case they will file a part year dual status return for that year).
Such change of status can have several advantages. First, they will only be subject to tax on US source income (ex., US effectively connected income, such as US source employment, business,[5] or (with the filing of a “871(d)” election) rental income (as well as capital gains on US real estate[6]), at graduated rates; or US investment income, such as interest, dividend, or (in the absence of the election) rental income, at flat “FDAP” rates – either 30%, or lower if reduced by a tax treaty). In this way, they would not be subject to US federal tax on non-US source income or subject to US federal tax on capital gains (even on US securities)[7]. Therefore, they can sell all of their securities after losing their green card status and becoming non-residents of the US, and not pay any US federal tax on any gains accrued while in the US.
However, there are disadvantages. Non-residents of the US cannot claim the standard deduction, and the types of itemized deductions they can claim is limited (generally, to the state taxes payable on US source effectively connected income). Second, the tax on US dividend income is a flat 30% (or lower, typically 15%, under a treaty), and cannot be reduced by deductions, or by being in a lower tax bracket. Third, a non-resident cannot file a joint return with their spouse (ex., even if their spouse is a US citizen or resident), unless they file a special election to make themselves full year residents. Their US spouse may now be subject to higher US tax rates filing as “married filing separate” than they would filing as “married filing joint”.
Expatriation Tax Consequences of Surrendering a Green Card
The most serious potential tax consequences of surrendering a green card are the potential penalties that could apply to “long term residents” who “expatriate”, under section 877A of the Code. [8] A “long term resident” is an individual who has held their green card for at least 8 of the last 15 years on the date of expatriation. Note that even one day counts as 1 year - for example, an individual who obtained his green card on December 31, 2010 would expatriate as a “long term resident” if he surrendered the card on January 1, 2017. Also note that an “expatriation”, for these purposes, can involve either a (voluntary or involuntary) surrender of a green card, or the filing of a non-resident (hybrid) tax return under a tax treaty.[9]
One consequence that applies to all individuals who expatriate as long term residents is that they have to file a Form 8854 with their US federal tax return for the year of expatriation. Form 8854 requires the individual to provide a balance sheet of all their assets and liabilities on the date of expatriation.
Another set of (potentially more serious) consequences applies to individuals who qualify as “covered expatriates” on the date of expatriation. Generally, this status applies if either: (a) the individual’s net worth is $US 2 million or more on the date of expatriation, (b) the average tax liability of the individual over the past 5 years exceeded (for individuals expatriating in $US 165,000,[10] or (c) the individual has failed to comply with their tax filing obligations in the prior five taxation years preceding the date of expatriation.
As a result, one common planning technique for individuals whose net worth is just above $US 2m, is to gift sufficient assets prior to expatriation so as to bring their net worth to below $US 2m. If they are domiciled in the US, they can use their lifetime gift tax exemption of (currently) $11.18m to make such gifts. If they are not domiciled in the US, they can gift assets that are not tangible US assets (ex foreign real estate or US securities). In addition, if they have not fully complied with their US tax obligations for the preceding five years (for example, they have not filed FBARs), they should ensure they do so before they expatriate.
If they still remain covered expatriates on the date of expatriation, they could be subject to the following penalties:
A deemed sale of their (non-pension) assets (ex. real estate, and securities held outside pension plans) at fair market value. Any net accrued capital gains in excess of (for 2018 expatriations) $US 711,000 will be subject to US federal capital gains tax.
A deemed distribution or settlement of all foreign (and hence “non-eligible”)[11] deferred compensation plans. This can include a deemed exercise of all foreign stock option grants, a deemed vesting of all foreign bonus and restricted stock unit grants, and a deemed distribution of all foreign pension plans. Such amounts are included into US taxable income and taxed at graduated rates.
This could result in double taxation, if the individual is later subject to full foreign taxes on a future (actual) distribution or exercise or vesting of such awards.
A future 30% withholding tax on amounts (actually) distributed, exercised, or vested under a (US) “eligible”[12] deferred compensation plan.
Notwithstanding this withholding, the final US tax could potentially be reduced through the filing of a US tax return, which would limit the US taxable income to the US source portion of the actual distribution/benefit.
A deemed distribution from an individual’s traditional IRA accounts or 529 education plans.
A future 30% withholding tax on income actually distributed from a non-grantor trust.
A 40% tax on any amounts received by a US citizen or domicile, by way of gift or inheritance, from a covered expatriate.
Note that unlike the general US gift or estate tax for US citizens or domiciles, the general $US 11.18 exemption does not apply for this tax. As a result, any dollar gifted or bequeathed to a US citizen or domicile from a covered expatriate would be subject to this tax.
For this reason, it may be advisable to ensure that one’s spouse and children expatriate at the same time as the individual who would qualify as a covered expatriate.
Summary
As one can see, significant consequences can arise (both beneficial and non-beneficial) from a voluntary or involuntary surrender of a US green card. It is imperative for individuals to obtain professional tax advice, either before they seek to turn in their green card, or before they commence living abroad without a returning resident permit to avoid potentially serious repercussions.
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[1] At the same time, such individuals can still challenge a determination of a US border officer and request a hearing of their status.
[2] Although it can constitute an “expatriating act” for purposes of the expatriation rules of section 877A of the Code (see discussion below).
[3] This statement will not be true if they become US citizens, or become income tax residents of the US by reason of either satisfying the substantial presence test in subsection 7701(b) of the Code, or filing a residency election under either subsection 6301(g), 6301(h), or 7701(b) of the Code. We will assume in this article that this will not be the case.
[4] Note that each US State has its own residency rules, which do not depend on the individual’s green card status.
[5] Employment and business income is generally considered “US source” if it relates to workdays in the US.
[6] As an example of “FIRPTA” properties, the sale of which is taxable to a non-resident.
[7] There is an exemption on gains from US sources for non-residents who were present in the US for 183 days or more during the year (paragraph 871(a)(2) of the Code), but this provision is often overridden by a tax treaty.
[8] The rules discussed in this article are for those individuals who “expatriate” on or after June 17, 2008. Different rules applied to individuals who expatriated before June 17, 2008.
[9] For example, if the individual who obtained the green card in 2010 moves to (say) Canada on January 1, 2017 and files a US Form 1040NR for the whole of 2017, under the treaty, he would be viewed as having expatriated in 2017, even if he kept the US green card for 4 more years.
[10] This tax is calculated after taking into account claims for foreign tax credits. On the other hand, if the individual has filed a joint return with a spouse, the tax liability is the joint liability, even if the bulk of the tax derives from the spouse’s income.
[11] Note that while the Code does allow foreign employers to file an election to avoid this consequence, and thus subject the covered expatriate to the “eligible” deferred compensation rules below, the IRS has not, as of yet, published the forms that would allow the foreign employers to make such an election.
[12] Even if the deferred compensation plan is US based, in order to be “eligible”, the covered expatriate will need to file a Form W-8CE with the employer, as well as an annual form with the IRS.
