cross-posted from Quora
John Richardson
Toronto lawyer: FATCA U.S. tax + renunciation of citizenship
CitizenshipSolutions
John Richardson, Lawyer (1982-present)
Answered Mon
What if Meghan Markle’s child is born a U.S. citizen? Would the child have any immediate tax and information reporting requirements to the IRS?
I note that the question (1) assumes that Ms. Markle’s child is a U.S. citizen and (2) the question focuses on BOTH tax and reporting requirements.
Would Meghan Markle’s children be U.S. citizens?
The majority view is “YES” her children would automatically be U.S. citizens. My minority view is “NO” – they would have the right to be U.S. citizens but not the obligation to be U.S. citizens. I have previously explained my reasoning on Quora here:
John Richardson’s answer to Could Meghan Markle’s children apply for US citizenship?
But, assuming that her child will be born a U.S. citizen, then
To be perfectly clear:
With the exception of gifts/bequests received from a “covered expatriate” the recipient of a gift is NOT required to pay tax on the value of the gift.
The recipient of a gift or bequest may be subject to penalty laden reporting requirements. These reporting requirements apply even though the value of the gift is NOT subject to tax.
Furthermore, this answer is really a “thought experiment” which explores the absurdity of certain aspects of the Internal Revenue Code apply to the lives of Americans abroad.
Here we go …
Tax Requirements …
The obligation to file a tax return would depend on the amount of taxable income the child received and whether that income met the thresholds for filing. It is unlikely (but not impossible) that the child could meet the income thresholds. For information on thresholds (which also depend on filing category) see:
Do I Need to File a Tax Return?
Reporting Requirements (which may exist independently of the obligation to file a tax return)…
The reporting requirements can exist independently of whether a tax return is required to be filed. It depends on whether there are sufficient facts to trigger the basic reporting requirements.
The child is a recipient of support from Harry
The child is probably going to live life as a normal baby and will be both supported and cared for by his/her parents. It is reasonable to assume that the child will receive financial support from the Harry (the father) who is (from a U.S. perspective) an “alien” or at least a foreign person.
Should the food, housing, medical care, toys, etc. received from Harry be considered to be a “gift” from a “foreign person”? If the answer is YES and the value of the support exceeds $100,000.00 USD then the child has a reporting obligation to the IRS (whether the child files a tax return or not). This is made very clear by Section 6039F of the Bible Of American Life – The Internal Revenue Code. It reads:
26 U.S. Code § 6039F – Notice of large gifts received from foreign persons
26 U.S. Code § 6039F – Notice of large gifts received from foreign persons
(a) In general
If the value of the aggregate foreign gifts received by a United States person (other than an organization described in section 501(c) and exempt from tax under section 501(a)) during any taxable year exceeds $10,000, such United States person shall furnish (at such time and in such manner as the Secretary shall prescribe) such information as the Secretary may prescribe regarding each foreign gift received during such year.
(b) Foreign gift
For purposes of this section, the term “foreign gift” means any amount received from a person other than a United States person which the recipient treats as a gift or bequest. Such term shall not include any qualified transfer (within the meaning of section 2503(e)(2)) or any distribution properly disclosed in a return under section 6048(c).
(c) Penalty for failure to file information
(1) In generalIf a United States person fails to furnish the information required by subsection (a) with respect to any foreign gift within the time prescribed therefor (including extensions)—
(A)
the tax consequences of the receipt of such gift shall be determined by the Secretary, and
(B)
such United States person shall pay (upon notice and demand by the Secretary and in the same manner as tax) an amount equal to 5 percent of the amount of such foreign gift for each month for which the failure continues (not to exceed 25 percent of such amount in the aggregate).
(2) Reasonable cause exception
Paragraph (1) shall not apply to any failure to report a foreign gift if the United States person shows that the failure is due to reasonable cause and not due to willful neglect.
(d) Cost-of-living adjustment
In the case of any taxable year beginning after December 31, 1996, the $10,000 amount under subsection (a) shall be increased by an amount equal to the product of such amount and the cost-of-living adjustment for such taxable year under section 1(f)(3), except that subparagraph (A)(ii) thereof shall be applied by substituting “1995” for “2016”.
(e) Regulations
The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section.
Note that the “cost of living adjustment” makes it clear that the threshold for reporting is now $100,000.00 USD.
The application of this rule is explained by the IRS here.
Gifts from Foreign Person
Further comments on the “foreign gift” rule …
Please note that to the extent that Meghan is the recipient of support from Harry and the Royal Family she is also required to report this support on Form 3520 (the information return where the gift is reported).
With respect to the Child – it might be better if Meghan (as a U.S. citizen) were to provide the support or if Harry never contributed more than $100,000.00 of support.
In any event, as in all “FBAR Marriages”, it would be wise for Harry and Meghan to keep VERY DETAILED records of the (1) the costs paid to support the child and (2) how much of that support comes from Harry (“the foreign person”).
No homeland American would have to worry about keeping records of the amount required to support their child because of IRS reporting requirements. But, if a U.S. citizen marries a “foreign person” (creating an “FBAR Marriage”), then there is a possibility of increased IRS reporting requirements.
Are the “foreign gifts” taxable as income to the child?
Generally no. Gifts are not generally taxable to the recipient.
But, there could be a problem if Meghan were to renounce U.S. citizenship as a “covered expatriate” and after renunciation provide financial support to the child. (If Meghan’s net worth exceeded $2 million USD when she renounced she would be a “covered expatriate”.)
S. 2801 of the Internal Revenue Code makes it clear that if the child were to receive gifts/bequests from a “covered expatriate” then the gift/bequest/support becomes taxable TO THE CHILD. This is explained in the following blog post:
Part 11 – S. 2801 of the Internal Revenue Code is NOT a S. 877A “Exit Tax”, but a punishment for the “sins of the father”
Therefore, it is important that IF Meghan renounces U.S. citizenship AND wants to provide support to her child that she first (prior to renunciation) give away enough of her assets so that she is no longer a “covered expatriate” (her net worth would need to be less than 2 million USD). Perhaps she could give the assets to the child in advance of renouncing U.S. citizenship. (Note that because the gifts came from Megan while she was still a U.S. citizen the gifts would not be from a “foreign person”.) But if she gives assets to the child in advance, she must be careful about creating a trust for the child which could conceivably generate more reporting requirements
Additional Reporting Requirements …
Trusts …
Internal Revenue Code Section 6048 imposes reporting requirements on the U.S. persons who receive property from “foreign trusts”.
26 U.S. Code § 6048 – Information with respect to certain foreign trusts
Note that IRS Form 3520 is used to provide the reporting in relation to both the “Foreign Gifts” and the “Foreign Trusts”.
Foreign Financial Assets …
Internal Revenue Code Section 6038D obliges U.S. persons to file reports on their foreign financial assets. See:
26 U.S. Code § 6038D – Information with respect to foreign financial assets
Basically if the child has “foreign financial assets” that exceed $200,000 USD AND the child is otherwise required to file a 1040 then the Form 8938 must be filed. Of course, the failure to file the Form 8938 will subject the child to more penalties. The instructions to Form 8938 are here:
https://www.irs.gov/pub/irs-pdf/…
Let’s not forget about Mr. FBAR …
Should the child have non-U.S. bank accounts, mutual funds or other investments that exceed $10,000 in value there may be an obligation to file an FBAR. In recent years, the IRS has made it very clear that – generally a child has the obligation to file his own FBAR!!! See the video in the following link.
Looking for Mr. FBAR? He’s Due October 15th! Learn the Latest…
And about “mutual funds” – let’s not forget Form 8621 (to report ownership of a PFIC”)
PFIC taxation and Americans abroad
Note that Form 8621 is required whether or not a 1040 is required.
In Conclusion …
It is essential that nobody rely on this as legal advice because I have not discussed a number of other possible reporting requirements.
A summary in the “form” (no pun intended) of Q and A …
Q. Will the IRS enforce these rules against Ms. Markle’s child?
A. Of course not. Babies (even U.S. citizen babies) are not born tax evaders.
Q. So, why I am providing such a detailed answer if the IRS wouldn’t enforce these rules against Ms. Markle’s baby?
A. To show you how insane the rules are that apply to U.S. citizens living outside the United States or who marry somebody who is not a U.S. citizen.
Q. What should U.S. citizens living outside the United States do?
A. Get rid of U.S. citizenship “quick time”.
Q. What should U.S. citizens who do NOT renounce U.S. citizenship do?
A. Report early! Report often! Report everything! – It’s the American way.
Q. Why are people getting rid of their US citizenship? A. It's because of the "10 Commandments of U.S. Citizenship" in a #FATCA and #FBAR world by John Richardson https://t.co/cbjEJ91Ijw
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) January 3, 2018
The IRS won’t enforce the rules against Meghan Markle and her child. But, they might enforce them against you.
Further reading (if you can stand the horror) …
IRS Form 3520, Penalties, and Whether to Make a Protective Filing – The CPA Journal
@Plaxy
“I wouldn’t think the UK government would contemplate breaking immigration law for a single second. A challenge would be inevitable.”
They did in the case of Zola Budd a south African bare footed long distance runner, after a push by the Daily Mail, they classified her as a ‘National treasure’ just in time for the 1984 Olympics.
https://www.theguardian.com/uk-news/2016/aug/24/zola-budd-passport-row-thatcher-government-olympics
But this is not 1984. The political situation is very different. The minority Tory government is clinging to power by a very slim thread, and has no reason whatever to masochistically hand ammunition to the opposition – let alone the Opposition. 🙂
And more to the point, there doesn’t seem to be any citizenship-related problem to solve. There doesn’t seem to be any Harry-related problem of any kind to solve, apart from the in-laws..
It’s all just celebrity-fan titillation.
I’ve always assumed that most countries have some sort of ministerial discretion to grant citizenship quickly when it’s deemed to be in the national interest, and this to me isn’t particularly controversial or offensive. I have no idea how such a move would play out, but I can’t imagine anyone anywhere on the political spectrum in Britain being opposed to a move that keeps the IRS out of the Windsors’ business. Even if you don’t like the royal family, you probably like the US government even less.
A quick pre-birth renunciation would prevent the minor princeling from inheriting US citizenship, but that may not be much of a burden if he or she (I have no idea) can easily renounce at 18.
@Plaxy
It seems a lot like Orwell’s 1984 to me!
@ Nony
“Even if you don’t like the royal family, you probably like the US government even less”
Well phrased…
And there you have it for me and probably much of the British public as well.
Nononymous:
“I’ve always assumed that most countries have some sort of ministerial discretion to grant citizenship quickly when it’s deemed to be in the national interest,”
Why would it be in the government’s interest to risk losing power?
“I can’t imagine anyone anywhere on the political spectrum in Britain being opposed to a move that keeps the IRS out of the Windsors’ business.”
A non-problem. The Windsors’ money is not remotely at risk from invasion by the IRS. 🙂
Heidi – “It seems a lot like Orwell’s 1984 to me!”
Indeed. Airstrip One here we come.
Or maybe not. Geography is a powerful determinant of alliances.
“Even if you don’t like the royal family, you probably like the US government even less.”
Fortunately, a referendum on the citizenship of Harry’s American Wife seems unlikely. 🙂
This horse is truly dead
@Portland, let me resuscitate it:
It wouldn’t surprise me if they had their baby in the US! I heard their medical is second to none.
Appears to be a hot topic, and not “optional” according to this person (DO consider the source):
“Question: But I never registered my children’s birth with the US Embassy, and my children have never been to the US. Does that matter?
Answer: No – they are still US citizens if they acquired citizenship at birth. For children born outside the US who acquire citizenship at birth, their citizenship is automatic and is not dependent on registration or obtaining a certificate. You may register your children’s birth abroad and obtain US passport for them, or they may do so themselves by applying for a Certificate of Citizenship if they are over the age of 18, if they wish to do so.”
http://www.mondaq.com/uk/x/756790/general+immigration/What+Do+You+Mean+My+Children+Are+US+Citizens
An individual born outside the US has to document their claim US citizenship in order to make use of the citizenship.
If they don’t want the citizenship, and want to get rid of it, they can either claim the citizenship in order to renounce it, or they can just not bother.
True for most, but might be a bit trickier for someone famous born into great wealth, about whom newspaper articles explaining the potential problems caused by US taxation are being written, even prior to their arrival.
Yes, if it’s been agreed that children of the marriage will shed citizenship at 18, or if said children choose to do so, renunciation will no doubt be performed.
“or a lot of them just aren’t filing US tax returns”
No kidding. They’re smarter than me.
“I’ve always assumed that most countries have some sort of ministerial discretion to grant citizenship quickly when it’s deemed to be in the national interest”
Oh yeah. Yes, Congress can pass a law making a person a US citizen. Yes, Congress can do it to anyone. Yes, Congress can do it to a renunciant.
If Britain doesn’t want to give Meghan British citizenship before the birth, maybe Canada should give her Canadian citizenship. She’s part of Canada’s royalty even after she emigrated.
“An individual born outside the US has to document their claim US citizenship in order to make use of the citizenship.”
Sure. Also, the US government has to document the government’s claim that the individual born outisde the US is a US citizen in order for the government to make use of the person’s citizenship. Or maybe not, maybe the government can just tell the court “we have records” instead of producing the actual documents.
Norman Diamond:
“…the US government has to document the government’s claim that the individual born outisde the US is a US citizen”
Why would the US want to claim an individual born outside the US was a US citizen?
“…in order for the government to make use of the person’s citizenship”
In what way?
If the individual is claiming citizenship, I can see why the USG might want to refute the claim. Or if the USG is accused of crime, I can see why the US might want to prove s/he was a citizen in order to apply to have the individual extradited to the US for trial in a US court.
I suppose the USG might conceivably bring a case in a US court arguing that such-and-such individual born outside the US was entitled to US citizenship, and therefore required to register for US military service or report his/her worldwide income for to the IRS. But that would be pointless, because unenforceable.
Has the USG ever in fact brought such a case? Or tried for any other reason to prove that an individual born outside the US is entitled to US citizenship?
Norman Diamond:
“Congress can pass a law making a person a US citizen. Yes, Congress can do it to anyone. Yes, Congress can do it to a renunciant.”
Can you mention a law that Congress has passed to make a renunciant or an individual born outside the US into a US citizen, against their will?
Norman Diamond:
(reposting to correct formatting)
Norman Diamond:
In some cases, no doubt.
It’s possible most don’t file because they assume, correctly, that it’s not necessary.
And perhaps they’re not investing their money in the US and don’t receive US income.
And have never ventured into a US tax court.
“Why would the US want to claim an individual born outside the US was a US citizen?”
Ask the ADCS plaintiffs. Ask Calgary411. Or make a guess.
“Congress can pass a law making a person a US citizen. Yes, Congress can do it to anyone. Yes, Congress can do it to a renunciant.”
‘Can you mention a law that Congress has passed to make a renunciant or an individual born outside the US into a US citizen, against their will?’
Right, in cases like the ADCS plaintiffs, Congress didn’t specifically name them. And again right, in cases where Congress specifically named a person in a law granting citizenship, it probably wasn’t against their will. But they could if they wanted. Robert E. Lee’s skeleton couldn’t say what his will was.
Norman Diamond:
“Ask the ADCS plaintiffs. Ask Calgary411. Or make a guess.”
In other words you were just shooting off your mouth again.