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
@JapanT
“This concept of the IRS leaving you alone if you leave them alone is flawed as it is based on old data. Data from the time before FATCA. Too early to have usable data for after FATCA’s implementaion, but they didn’t dream it up and trick or force all nations to go along for no reason.”
The push for Fatca came in the wake Swiss UBS scandal where they were primarily after those in the US who were investing and hiding income abroad. The addition of US citizens living their ordinary lives abroad came as a bonus because of CBT and of course those compliance condors jumping on the bandwagon to scare all those law abiding US citizens who didn’t have a clue about CBT into ‘compliance. Penalties were added as a bonus after the IRS realized what it could mean for potential increased revenue.
I really think the IRS don’t have the manpower to chase up every US citizen living abroad. How could they know what they could collect? Many US citizens do have other passports, in which case collection would be nigh impossible.
I know that is not so in your case but they would need to know that you owe them something to revoke your passport. You could be a stay at home Dad with no income, you may not have accounts over $10,000 and not need to file. How the hell do they know all this and would it be worth taking the time and expense to find out? I sincerely doubt it.
Heidi –
“The addition of US citizens living their ordinary lives abroad came as a bonus because of CBT and of course those compliance condors jumping on the bandwagon to scare all those law abiding US citizens who didn’t have a clue about CBT into ‘compliance. Penalties were added as a bonus after the IRS realized what it could mean for potential increased revenue.”
Do you have a link to a reliable source on that? Which penalties do you mean?
Given the difficulties of extraterritorial enforcement, and the low number of USCs filing from outside the US, penalties aimed at non-US-residents would seem to be an unlikely tactic for increasing revenue.
There was concern in the wake of 9/11, as I understand it, over the ease with which US residents were able to move money abroad. FBAR penalties were increased then. or so I’ve read. Could be wrong.
@Plaxy
Do you have a link to a reliable source on that? Which penalties do you mean?
FBAR penalties. As I remember they were added later after the implementation of FATCA.
Nope, no source, but as you have the reputation as the Brock source finder general maybe you can come up with one if it’s that important.
I was just trying to allay the fears of JapanT, what is your purpose on here?
@Plaxy
OK, just being defensive.
Perhaps under the usual US excuse of finding terrorist money
“what is your purpose on here?”
Countering the fears propagated by tax advisers 🙂
@plaxy
“Even though you’re relying on your US citizenship to be able to stay where you are or live anywhere else.
@plaxy
“You could be a stay at home Dad with no income, you may not have accounts over $10,000 and not need to file. How the hell do they know all this and would it be worth taking the time and expense to find out? I sincerely doubt it.”
Except for the fact that my banks have been reporting all info they have on me, which I’ve asked you three times if you’ve read any IGA that requires all my babks are providing, for 4 years. The IRS is not chasing after anyone, on that point you are correct. They are just sitting back and letting the condors and/or our banks and other FIs do the dirty work for them.
Again, I know that there is at leadt one person in the US using my ID. They have an arrest record in my name and either lawsuits or leins against them or both, again in my name. With no way to challenge a passport revokation and being questioned upon applying for renewal about compliance, again the IRS need not soend time or money. I either rob a bank and pay them, find a creative way to gain Japanese citizenship or risk the loss of my passport when I have to renew it.
Yes, I know adult dual nationals exist. I have met one, exactly one. All other non Japanese adults I know are monocitizenship folk like myself. Have no idea who out numbers who, but there are a lot of us with just the one citizenship.
Sorry, my last should be directed at Heidi instead of plaxy.
Opps.
@plaxy (for sure this time)
“Given the difficulties of extraterritorial enforcement, and the low number of USCs filing from outside the US, penalties aimed at non-US-residents would seem to be an unlikely tactic for increasing revenue.”
Easy peesy. It’s called extortion. Pay or lose passport. No effect on you, you have another. No payday for the IRS from me, I just lose my passport. The news item though would be enough to scare others to come up with the cash to pay so that they too do not lose their families.
Japan T:
That Heidi’s comment, not mine.
@JapanT
I thought you had posted on here that you had kept your accounts under the threshold by transferring all assets to your wife’s name?
Anyway, IMO unless you are worth the trouble, I believe they will leave you alone. There are thousands ++ in your situation.
@Japan T
“questioned upon applying for renewal about compliance”
How so? There is no tax question on the current US passport renewal application. You are merely asked to supply an SSN.
I said:
“There was concern in the wake of 9/11, as I understand it, over the ease with which US residents were able to move money abroad. FBAR penalties were increased then. or so I’ve read. Could be wrong.”
According to the Andrew Mitchel site (https://intltax.typepad.com/intltax_blog/2015/11/the-escalation-of-offshore-penalties-over-the-last-20-years.html),
“Starting in 2005, a penalty of $10,000 could be imposed for non-willfully failing to file the FBAR.”
There’s quite a list of various penalties being increased, though, starting in the 1990s, so the FBAR increase might simply be part of the general trend towards punitive penalties.
Or no SSN if you don’t have one.
@heidi
I stopped responding for awhile due to a comment you made earlier. Do not which thread, but you said that it is a USC’s right to renounce and that they can not prevent one from doing so. This ignores the fact that there are many who relinquished USCship only to have to go through some pricess once again to secure their CLN. This is truely profound. Let’s take any of the countries where CLNs are required for normal banking as an example. A citizen of that country with documentation from that countries gov. supporting their claim to that nation’s citizenship must also provide a document from another country to open or maintain a bank account in their country. A bank in such a county will not accept a client who is a citizen of that country if they do not present a document from the US if that applying citizen was once a USC.
What good is the right to leave if one is denied the benefits of that right?
I know that this is not universal, but after naturalizing as a Japanese citizen, one has two years to relinquish their former citizenships by the laws of their former countries. While this has not been enforced, there is at least one documented case a of USC who naturalized as a Japanese but had it yanked because he did not relinquish his USCship. True, he did not renounce because he did not want to pay the exit tax. However, if one renounced but not “cleanly” and was unable to obtain a CLN, then how would one prove to the Japanese gov. that they were no longer a US citizen?
They may not beable to keep you frim renouncing but thay can prevent upu from being able to live as if you have. A distinction of little difference from my point of view.
If memory serves, FBAR fines came oblut in 2009 and FATCA in 2011.
“@Japan T
“questioned upon applying for renewal about compliance”
How so? There is no tax question on the current US passport renewal application. You are merely asked to supply an SSN.”
True but the practice of using your SSN to check against various things as outlined on my application has not changed. They just changed the wording.
“Or no SSN if you don’t have one.”
Born in the US and lived there or on one its naval vessels until graduation college. I certainly have a SSN. Thought about just paying the $500. fine for not providing a SSN but the statement that despite providing it being voluntary, failure to provide it would bring a fine and could cause delay and or denial of the application. “Voluntary” they said….hey plaxy, they speak your language.
Japan T –
“hey plaxy, they speak your language.”
Yep. And they probably don’t have any more sympathy for you than I do.
@plaxy
Don’t care a wit for your sympathy or lack there of.
But I must wonder at one who continually calls being extorted a choice.
But Japan T, the US has no need to resort to extortion to require you to disclose your SSN on a passport renewal form. The SSN came from the US, as did the passport. The US giveth the passport and the US reneweth the passport and can very easily stop renewing the passport.
Per an earlier comment, the CLN is granted (in exchange for $2350) with no consideration of tax issues. Failure to pay exit tax would have not prevent acquiring Japanese citizenship because one would have the CLN in hand already. There is no such thing as “unclean” renunciation.
@heidi
Yes, I am below the limits you give. No matter. There is no mention of any specific balance triggering reporting in the documents one of my banks gave me and made me sign. According to my bank and the Japan Bankers Association, all accounts held by US persons, including non USCs residing in Japan AND Japanese citizens RESIDING in Japan if the physical presence test is met are being reported to “U. S. tax authorities”. Yes, I am far below the legal FATCA limits, but being reported all the same. Just as I and others said would happen several years ago.
“But Japan T, the US has no need to resort to extortion to require you to disclose your SSN on a passport renewal form. The SSN came from the US, as did the passport. The US giveth the passport and the US reneweth the passport and can very easily stop renewing the passport.”
Actually, no. As a USC, I am free to leave and return to the US at will. The passport is merely a service provided by the US gov, at my expense, $150 for my last passport, to facilitate entering and leaving other countries. Or that is the case if the US decides to follow its own laws and treatries blah, blah blah.
I can tell you that my British friends were shicked at the idea of a passport being denied. They said the bar to revoke a British passport is much much higher. Criminal activity or credible suspicion is a minimum requirement.
“Per an earlier comment, the CLN is granted (in exchange for $2350) with no consideration of tax issues. Failure to pay exit tax would have not prevent acquiring Japanese citizenship because one would have the CLN in hand already. There is no such thing as “unclean” renunciation.”
See, it was a statement much like this one that gave me much hope a year or two ago. So deep I dove into it. I am shocked that I can not recall what the hang up was but there was one. I know I looked for a way around it but found a road block on each new possible path. I also know that having this one last escape route cut damped my spirits extremely. Yet, I can not recall what it was. I do know I wrote of it here though. Something about my situation that requires a “clean” break.