Several years ago, a client, let’s call him Flynn, hired us to prepare his final tax return before expatriating. I wanted to share his story to serve as a cautionary tale to everyone out there who is planning on expatriating without the advice of an international tax advisor.
Flynn was a naturalized U.S. citizen; a dual citizen with Ireland. He met and married Karen, an American, and they lived a pretty normal, routine life in the U.S. until Flynn retired. Looking for a little adventure, they relocated to South America where they lived for several years before Karen, unfortunately, died. With no real ties to the U.S. anymore, Flynn decided to remain in South America and figured now was the time to expatriate. Luckily, this is when he contacted us.
During our initial consultation, I asked several questions to determine if he was going to be a covered or non-covered expatriate. He said that to the best of his knowledge, he would be an uncovered expatriate. This means he would be exempt from paying an exit tax, subjecting any U.S. heirs to the estate or gift tax, and potentially being banned from entering the U.S. And, from what he first told me, it appeared he was right. He was under the net worth and income tax liability thresholds and he assured me that he had been tax compliant for the past 5 years—all criteria for being an uncovered expatriate. He based his belief that he had been tax compliant on the fact that his long-time accountant had prepared his returns, and he had full confidence in his accountant. I recommended that he send me copies of his past 5 tax returns and FBARs, just so that I could review them and verify that everything was in order.
Well, it was a good thing I had a look at his past returns! Flynn’s returns and FBARs were riddled with errors rendering him non-compliant. It was clear that Flynn had made the effort to comply – he had provided all necessary information to his tax preparer – and trusted that his tax preparer prepared his returns accurately. Unfortunately, his tax preparer didn’t have the knowledge or experience to do so.
Here are a few examples of errors made:
- The question on Schedule B asking whether he had a foreign account was answered no, although Flynn had several foreign accounts, and his tax preparer knew he lived overseas
- When reporting asset values on Form 8938, the wrong exchange rates were used.
- Income and expense information was left off of an international information return for a foreign entity.
Although these seem like small compliance deficiencies, they do constitute tax non-compliance in the eyes of the IRS, meaning Flynn could not certify under penalty of perjury on Form 8854 that he was, in fact, tax compliant and therefore an uncovered expatriate.
Had he expatriated without me reviewing his tax returns, and improperly certified tax compliance, and then the IRS had examined his returns, they would have identified the compliance deficiencies, which would have rendered him a covered expatriate. Fortunately for Flynn, he had hired us to assist him with his expatriation and we were able to identify his tax compliance deficiencies and amend his returns and FBARs to bring him into compliance so he could expatriate as an uncovered expatriate.
This story outlines the potential danger of using a tax professional without international tax experience to prepare your returns when you have foreign income and assets. It also shows how close this guy came to be a covered expatriate, along with all of the negative baggage that goes with it—simply because he believed he was in compliance.
He was lucky he hired us to assist in his expatriation. The moral of the story—don’t expatriate without the assistance of an international tax specialist to ensure everything is done properly.