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
@Japan T,
“As I have understood the situation, if my passport is in some way nullified, as long as I avoid dealings with the police, no problem until time to renew my residence card.”
When it is time to renew the residence card, you are supposed to show either a passport OR an explanation of why you cannot show one:
http://www.moj.go.jp/nyuukokukanri/kouhou/nyuukokukanri10_00011.html
Whether “I just don’t have one” is an acceptable explanation, I don’t know. Lots of zainichi Koreans don’t have passports, though they are somewhat of a special case, of course. Probably worth asking immigration directly about this specific case.
“Can you imagine if all 193 countries in the world would apply the same taxation rules as the USA. One would ( theoretically speaking) have to fill out 193X W-8WEN type forms.”
It’s not that bad. We just need reciprocity. The only people who will be forced to fill out 193X w8-BEN type forms will be residents of the US.
“Summary: even if your [non-Japanese] passport expires, it doesn’t affect your visa status. Of course, you wouldn’t be able to leave the country, but neither will you get deported.”
Wow, I hope that’s true. As a Canadian it doesn’t affect me but we know who needs it. After the change in the way foreign thingies became temporary residents, the residence card is enough and we don’t get stamps in our passports any more. Maybe if Bobby Fischer were alive today, maybe he’d just be denied boarding instead of being jailed.
“A non-US citizen can’t file a US tax return to reclaim excess tax, so less tax is withheld. AIUI. ICBW. etc”
A non-US citizen can submit a 1040NR. The person doesn’t even have to be a renunciant or resident or former resident or anything. If they paid too much, they can get a refund. If they paid too little they’re “required” to submit the 1040NR and pay the difference, and I suppose the IRS could levy the underlying US asset otherwise.
“A non-US citizen can submit a 1040NR. ”
Yes – I should have said:
“A non-US citizen can’t file a US-citizen tax return (Form 1040) in order to claim US citizen tax breaks, thus reducing tax paid.”
As I understand it. Best to ask the bank for the explanation.
@foo
“@Japan T,
“As I have understood the situation, if my passport is in some way nullified, as long as I avoid dealings with the police, no problem until time to renew my residence card.”
When it is time to renew the residence card, you are supposed to show either a passport OR an explanation of why you cannot show one:
http://www.moj.go.jp/nyuukokukanri/kouhou/nyuukokukanri10_00011.html
Whether “I just don’t have one” is an acceptable explanation, I don’t know. Lots of zainichi Koreans don’t have passports, though they are somewhat of a special case, of course. Probably worth asking immigration directly about this specific case.”
We did dig around through the various laws and regulations, but that would have been 3 or four years ago now. Seems worth a new dig. Thanks again.
@Slingy
My guess is that banks in Canada don’t require a W8/W9 for basic accounts, they will use a different FATCA/CRS form now to cover all possible tax residencies, but investment accounts might still request a “prophylactic” W8/W9 because of the possibility of US investments.
Since the child is under the care of its parents, any “gift” to the child (except trusts etc.) is likely to be really owned by the parents. For example, in ordinary families (not this one, obviously), a gift of baby clothes etc. is likely to end up sold by the parents, or passed down to a sibling.
As I understand it, Meghan Markle is now a British citizen. It was required, in order to become part of the royal family. I do not know, if she has dual citizenship now. I am certain that any of their children will also be British citizens.
If she is a UK citizen, it has not been publicly announced. Similarly, if she renounced US citizenship, it has not been publicly announced. On what basis do you understand that she has taken UK citizenship?
If she is still a US citizen when she gives birth, her child will be a US and UK citizen (regardless of whether the parents register the birth).
By this news account, http://time.com/money/5243649/meghan-markle-uk-citizen/
Nononymous wrote “If she is still a US citizen when she gives birth, her child will be a US and UK citizen (regardless of whether the parents register the birth).”
That is not true. Automatic US taint only applies if BOTH parents are US citizens. If one parent is a non-US citizen, the American parent or the child (later in life) MAY apply for citizenship and have it granted immediately. It is not, however, automatically given without application. My child is, fortunately, has only one American parent, and travels in and out of the US on a non-US passport as the child is not registered as a US citizen. No one has ever questioned this at all, and the US embassy in my country has confirmed this as well. As long as Meghan Windsor does not register the child with the US embassy in London, the child is not American, but could be in the future.
“My child is, fortunately, has only one American parent, and travels in and out of the US on a non-US passport as the child is not registered as a US citizen.”
It’s not because your child isn’t registered as a US citizen born abroad. It’s because your child doesn’t have a US birthplace.
A person with a US birthplace has to prove loss of US citizenship if wanting to enter the US on a non-US passport.
In theory. Unenforceable, in practice, but can cause hassle and delay.
@Roseanne
A child would be considered a US citizen whether registered or not if certain residence criteria of the US parent have been fulfilled.
https://travel.state.gov/content/travel/en/legal/travel-legal-considerations/us-citizenship/Acquisition-US-Citizenship-Child-Born-Abroad.html
@Roseanne
Your child is fortunate to avoid the label, I don’t think Markle’s child will be able to avoid the publicity and do likewise, that’s even if Markle even wants non registration. Judging by other royal marriages, she may choose to hedge her bets!
Plenty of children get born outside the US, get registered by their parents as US citizens, travel on a US passport during childhood, then as adults drop the US citizenship, never renew the passport, and are simply citizens of their native land. As mine have done.
Heidi – “Judging by other royal marriages, she may choose to hedge her bets!”
Innit. 🙂
@Roseanne
There is an endless debate over whether a child born to one US parent who meets the residence criteria to transmit US citizenship (5 years living in the US, 2 of those years after age 14) is or is not a US citizen if their birth has not been registered with a US consulate. The consensus belief is that the child is technically a US citizen even if the US government has not been informed of their existence.
However, it’s a rather pointless how-many-angels-on-the-head-of-a-pin sort of debate because if the child has a non-US passport with non-US birthplace, they can easily live their lives without the problems of US citizenship (unless of course they are born into the Royal Family and great fame).
However, there is one possible problem for such children: travel to the US with a US-born parent, particularly on a US passport, can sometimes cause questions and delays on entry, or even denial of visas if a consular official believes the child to be a US citizen.
For life-planning purposes it’s always safer to assume that such a child is a US citizen, and to behave accordingly – never mention parental US citizenship around any financial institution, lest they be suspected of US person status and subjected to FATCA reporting.
My daughter’s birth outside the US was registered, unfortunately – I had no idea of the implications. Now that she’s 18, she has been carefully instructed to deny any connection to US citizenship. She travels to the US on a Canadian passport without difficulty, and knows not to acknowledge it when opening bank accounts. Later in life she may renounce (I’ll happily pay) but for now it’s useful to have in the back pocket, as you never know where life may lead.
Nononymous:
“For life-planning purposes it’s always safer to assume that such a child is a US citizen, and to behave accordingly – never mention parental US citizenship around any financial institution, lest they be suspected of US person status and subjected to FATCA reporting.”
Having a US citizen parent is not a crime. There is absolutely no reason for a child or a parent to have skulk around not mentionin things. When the child grows up, s/he can choose whether s/he wants US citizenship or not.
A person with no IS birthplace is not a risk to a bank and can simply confirm to the bank that s/he is tax-resident only in the residence country.
The situation for an individual with a US birthplace is exactly the same, except that if they decide they don’t want US citizenship they will need a CLN to prove they’ve renounced it, and that will cost $2350.
@plaxy
Their are reports on the FB group of banks in Israel treating such folks as US persons, based on parentage. No idea how the banks know. Hence a certain amount skulking may be advisable, in some situations. (Also, Japan!)
Nononymous:
I don’t think skulking is ever an advantageous life choice.
If US citizenship becomes a problem, the solution is to renounce, if possible.
Those who can’t renounce because they can’t afford the fee, are in a very unfair position, which skulking is unlikely to alleviate. IMO