A letter (yes, an old-fashioned, sent-by-post, paper letter) arrived in my office today from an overseas lawyer seeking advice for his client.

The client was born in the United States. When he was a month old, he returned with his parents to their home country, where he has now lived for more than 40 years. This client lives, works and pays taxes in his “home” country, and carries that country’s passport.  At some point in the past – the specifics of why and how are not described in the letter – the client obtained a U.S. passport.  Apparently, this passport expired many years ago. The client has not formally renounced U.S. citizenship but, despite his brief possession of an American passport, has also never voted or filed tax returns in the United States.

My foreign colleague provided this thumbnail sketch of his client’s U.S. connection as a prelude to asking for advice on three questions:

  1. Is the client obligated to file U.S. tax returns on the client’s worldwide income, even if all of it is earned outside the United States?
  2. Is the client subject to U.S. tax on earnings generated outside the United States?
  3. Is the client’s property subject to U.S. estate tax at death?

The simple answers to these questions are: yes, yes and yes.

  1. U.S. citizens are subject to U.S.tax on their worldwide income, regardless of where they live.
  2. Any property owned by them at death is subject to U.S.estate taxes.
  3. A U.S. citizen is required to file a U.S. tax return annually if that citizen’s gross income is at least $9,500. If the citizen is married and filing separately for his or her spouse, the threshold amount can be as little as $3,700.

That said, this client may not owe any U.S. tax. First of all, the client would be entitled to exclude earned income up to $92,900 in 2011, and would be able to apply any tax paid to his “home” country on any income not covered by the earned income exclusion. Earned income means any remuneration for work, which could include consulting fees or other self-employment income. It does not include interest, dividends, capital gains or rental income. However, on those items of income, the client would be entitled to credit any foreign taxes paid to his or her home country against any U.S. tax that might be due on such income. The good news is, failure to file a U.S. tax return generates a penalty only if tax is in fact owed. Otherwise, the penalty is $100. In other words, the trick is distinguishing between a molehill and a mountain.

In addition to the tax returns this client should have been filing, he also should have been filing Foreign Bank Account Reports (FBAR’s) each year.  While failure to file those reports could theoretically have created a much more serious financial concern for the client than not filing the tax returns, as you my have read in my last post, the IRS recently confirmed the obvious in declaring that it will not penalize people who do not owe any tax and are otherwise tax compliant in their home countries.

The real question is whether the client wants to retain U.S. citizenship.  If not, there are two options to consider – renunciation or relinquishment. Most people are familiar with renunciation. Few are as familiar with relinquishment. I will address the differences between them in my next post.


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