On March 5, 2020, the U.S. Department of Justice unsealed an indictment, charging a Russian-born billionaire Oleg Tinkov with filing false U.S. tax returns. Tinkov, who held U.S. citizenship, was the indirect majority shareholder of an online bank (TCS) that provided its customers with financial and bank services. The indictment alleges that as a result of an IPO on the London Stock Exchange in 2013, Tinkov beneficially owned, through a British Virgin Islands structure, more than $1 billion worth of the bank’s shares. The indictment further alleges that three days after the IPO, Tinkov renounced his U.S. citizenship. Renunciation of U.S. citizenship can be a taxable event if certain net worth or income conditions are met and can result in a so called “exit tax”. Tinkov was required to report to the IRS the constructive sale of his worldwide assets, report the gain on the constructive sale of those assets to the IRS, and pay tax on such gain to the IRS. Although Tinkov allegedly beneficially owned more than $1 billion of TCS shares at the time of his expatriation, he filed a false 2013 tax return with the IRS that reported income of less than $206,000, and a false 2013 Initial and Annual Expatriation Statement reporting that his net worth was $300,000. Tinkov was arrested in London, posted bail, and now awaits an extradition hearing. If convicted, Tinkov faces up to three years in prison for each of the counts.
This case serves as a good illustration of the complexities of the U.S. tax system and reminds us that failure to comply with the U.S. tax laws can haunt taxpayers even after they renounce their U.S. status.
What is the Exit Tax and Who Does it Apply To?
Giving up your U.S. citizenship is considered a taxable event, i.e. the IRS treats the date of the renunciation (or technically, the date before the renunciation) of the citizenship as a date of the virtual sale of the assets at a market price. The U.S. exit tax rules affect not just U.S. citizens, but also permanent residents, i.e. Green Card holders in at least 8 of the last 15 tax years. The exit tax regime applies to the taxpayers in one of the following three categories:
- Individuals with an average income tax liability in excess of $168,000 (as of 2019, as indexed for inflation) for the five tax years prior to the expatriation date.
- Individuals with a net worth of $2 million or more as of the expatriation date.
- Individuals who cannot certify under penalty of perjury that they have complied with US tax requirements for the five years preceding the expatriation date.
Falling into any one of these three categories would make an individual subject to the U.S. exit tax rules.
A taxpayer who expatriates is deemed to have sold all his or her property, regardless of where that property is situated, for its fair market value on the day before his or her expatriation date. The exit tax is essentially the application of U.S. income tax on the portion of that phantom gain over $725,000 (2019 amount). The “expatriation date” for a U.S. citizen is the date on which the individual relinquishes his or her citizenship. The taxpayer is obligated to file Form 8854, Initial and Annual Expatriation Statement.
In September 2019, the IRS announced procedures that enable certain individuals who relinquished their U.S. citizenship to come into compliance with their U.S. tax and filing obligations and receive relief for back taxes. The Relief Procedures for Certain Former Citizens apply only to individuals who have not filed U.S. tax returns as U.S. citizens or residents, owe a limited amount of back taxes to the United States and have net assets of less than $2 million. Only taxpayers whose past compliance failures were non-willful can take advantage of these new procedures. Many in this group may have lived outside the United States most of their lives and may have not been aware that they had U.S. tax obligations.
Eligible individuals wishing to use these relief procedures are required to file outstanding U.S. tax returns, including all required schedules and information returns, for the five years preceding and their year of expatriation. Provided that the taxpayer’s tax liability does not exceed a total of $25,000 for the six years in question, the taxpayer is relieved from paying U.S. taxes. The purpose of these procedures is to provide relief for certain former citizens. Individuals who qualify for these procedures will not be assessed penalties and interest.
If you have any questions about U.S. expatriation tax requirements, or questions about compliance with reporting of foreign assets for U.S. tax purposes, please feel free to contact Former IRS Attorneys at Holtz, Slavett & Drabkin for a consultation. You can call us at 310-550-6200.