The
situation, in a nutshell: you and your spouse are both U.S. citizens.
You renounce your citizenship, but your spouse remains a U.S. citizen. You
can elect (discussion below) to be treated as a U.S. taxpayer, even
though you are no longer a U.S. citizen and are not living in the United
States.
What the election does :
If you elect to be a U.S. taxpayer, the result is that you treated like a resident for income tax purposes, and for withholding on wages paid to you:
A nonresident alien individual with respect to whom this subsection is in effect for the taxable year shall be treated as a resident of the United States—
(A) for purposes of chapter 1 for all of such taxable year, and (B) for purposes of chapter 24 (relating to wage withholding) for payments of wages made during such taxable year.
What the election does :
If you elect to be a U.S. taxpayer, the result is that you treated like a resident for income tax purposes, and for withholding on wages paid to you:
A nonresident alien individual with respect to whom this subsection is in effect for the taxable year shall be treated as a resident of the United States—
(A) for purposes of chapter 1 for all of such taxable year, and (B) for purposes of chapter 24 (relating to wage withholding) for payments of wages made during such taxable year.
See 26 U.S.C. §6013(g)(1).
1. Makes you taxable on worldwide income
"Chapter
1" means Title 26, Subtitle A, Chapter 1 of the United States Code. It
contains Sections 1 - 1400UU of the Internal Revenue Code. These are the
rules that impose income tax.
This
means that a nonresident alien (you, the recently renounced citizen,
now a nonresident alien) is subject to U.S. income tax on worldwide
income.
2. Withholding on your wages
"Chapter
24" refers to Title 26, Subtitle C, Chapter 24 of the United States
Code. It contains Sections 3401 - 3406 of the Internal Revenue Code.
These are the rules that say an employer is supposed to withhold tax
from wages paid to you, and remit the withheld tax to the IRS.
This
means that if you have "wages" as defined in Chapter 24, your employer
will withhold tax on those wages and deposit those withholdings with the
IRS. It will be up to you to file a tax return and claim a refund, if a
refund is due.
Since
we are assuming you (the one who renounced your citizenship) do not
have any income, we don't care about the withholding rules.
3. The filing rules
The
election also applies the rules of Internal Revenue Code Sections 6012,
6013, 6072, and 6091 to the nonresident alien. See 26 C.F.R.
§1.6013-6(a)(1).
These are merely mechanical rules that tell you what, when, and where to file when you are inside the U.S. tax system:
-
Section 6012 lists the people who are required to file income tax returns (including the minimum amounts of income required to file, etc., thus answering the question "do I even have to file a tax return at all?");
-
Section 6013 allows a joint tax return for husband and wife (this is the "what do I file?");
-
Section 6072 contains the filing deadlines ("when do I file?"); and
-
Section 6091 contains the rules for where to file tax returns ("where do I file?")
Why make the election? MFS vs MFJ
Let's
look at why you would want to make the election. You
will only make the election to be a U.S. taxpayer if you think it will
save you money. This is usually because of the difference in tax
treatment for married couples who file "married filing separately" as
compared to "married filing jointly."
Fortunately,
math will give you the answer to this. Every tax return preparation
software package will allow you to figure this out.
My
bet is that when you run the numbers, the marginal tax savings will be
small. Maybe several hundred dollars, maybe a few thousand at best.
Why make the election? Section 1041
If you can't tell, I am unimpressed by the cost/benefit of saving a few thousand dollars on a joint tax return.
However,
there is a definite strategic advantage to making the election when you
want to move assets between the U.S. citizen spouse and the spouse who
renounced citizenship.
Example
Let's
say that a husband (no income stream, renounced U.S. citizenship) and
wife (has the income stream, is still a U.S. citizen) have two jointly
owned assets. One asset is a piece of real estate, worth $500,000. The
other asset is a bank account containing $500,000 of cash.
For reasons known to the two of them, they want the husband to own the real estate, and the wife to own the cash.
Hint: let's pretend the wife is the U.S. citizen and the husband is the one who renounced U.S. citizenship, and let's further pretend that they live in Dubai, where there is no income tax.)
For reasons known to the two of them, they want the husband to own the real estate, and the wife to own the cash.
Hint: let's pretend the wife is the U.S. citizen and the husband is the one who renounced U.S. citizenship, and let's further pretend that they live in Dubai, where there is no income tax.)
Without the election
Ordinarily,
transfers of property between spouses will not trigger any tax. That's
what Internal Revenue Code Section 1041(a)(1) says.
However,
if one of the spouses is a nonresident alien, the special rule (no tax
for transfers between spouses) will not apply. See Internal Revenue Code
Section 1041(d).
First
look at the "without making the election" scenario. If the husband gets
a deed to the real estate as his sole property, and the wife gets 100%
ownership of the bank account, this is the equivalent of the U.S.
citizen wife selling her half of the real estate to her husband (a
nonresident alien because he renounced U.S. citizenship) for $250,000
cash.
The U.S. citizen wife, in that case, will pay capital gain tax on the "sale" of half of the real estate to her husband.
With the election
Now
let's pretend that our renouncing U.S. citizen makes the election under
Section 6013(g) to be a U.S. taxpayer. This makes him a "resident
alien" for purposes of "Chapter 1" of the Internal Revenue Code. And
guess what? Section 1041 is in Chapter 1.
Let's re-apply the rule of Section 1041(a)(1) to the scenario.
The U.S. citizen wife transfers 100% ownership of the real estate to her husband, who is no longer a citizen but is a "resident alien" for purposes of income tax computations.The husband transfers 100% of the bank account to the U.S. citizen spouse.
This
is a tax-free event because the husband is a "resident alien" which
means that the rule of Section 1041(d) does not apply to this scenario:
Subsection (a) shall not apply if the spouse (or former spouse) of the individual making the transfer is a nonresident alien.
Well, the spouse of the individual making the transfer is not
a nonresident alien. One spouse is a U.S. citizen, and the other spouse
is a resident alien. We can apply the default rule of Section
1041(a)(1) and this transfer is tax-free.
Why would you want to do this?
Simply
put, you would do this in order to re-balance assets between the U.S.
citizen spouse and the spouse who renounced citizenship. The objective
would be to get all of the highly appreciated assets into the name of
the nonresident spouse, and get cash into the hands of the U.S. citizen
spouse.
Make
the election. Do the rebalancing of assets. Then revoke the election.
Have the expatriate spouse sell the assets without capital gain.
In
my example, the wife ends up with $500,000 cash, and the husband ends
up with the real estate. If he terminates the election to be a resident
alien for income tax purposes, he can then sell the real estate
tax-free.
Basis
The
transferee spouse has basis in the property received that is equal to
the transferor's basis in the property transferred. See T. Regs.
§1.1041-1T(d), Q-11 and A-11.
That means the U.S. citizen spouse who holds the $500,000 of cash will have basis of $500,000 in that cash.
The
husband (who renounced, then made the election under Section 6013(g) to
be a resident taxpayer again) will have whatever basis the wife had in
the real estate.
When
he sells the real estate, he will be taxable on all of the capital
gain. But he will cancel the Section 6013(g) election, and no longer be a
U.S. taxpayer. The fact that this capital gain is taxable means nothing
to him.
Gift
There
are special rules that apply to gifts by U.S. persons to noncitizen
spouses. We don't have to worry about these special rules. Let us
concede that the rules apply to this situation -- and the transfer of
real estate by the U.S. citizen spouse to her non-citizen husband.
The
transfer is not a gift. It cannot be a gift from one spouse to the
other, because fair market value was given in return: the wife
transferred $250,000 of real estate to her husband, and the husband
transferred $250,000 of cash in return.
How much did the wife give away, getting nothing in return? Zero.
A
“gift” is any transfer for “less than an adequate and full
consideration in money or money's worth.” 26 U.S.C. §2512(b). The
transaction I described is one in which each side received money or
money's worth exactly equal to whatever they gave up.
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