Increasing numbers of United States citizens are renouncing their citizenship.
‘Expatriations’ have increased exponentially: from several hundred annually pre-2010, to over 5,400 in 2016 – and they’re estimated to hit 6,800 in 2017. Reasons range from pervasive FATCA rules, to compliance costs, to investment concerns, to daily life in a foreign country.
But if you’re a US citizen and are considering renunciation, you should beware of potential tax costs that could bite you on the exit.
An ‘exit tax’ can apply to either US citizens giving up citizenship, or long-term green card holders. And if you’re a green card holder, remember that an expired card doesn’t relieve you of US tax obligations. Confirm with a tax advisor if the exit tax is applicable and how expatriation is triggered for you.
If any of the following conditions apply, you will be considered a ‘covered expatriate’ and could face a substantial tax on the ‘deemed sale’ of ALL of your assets, plus the immediate tax on ALL of your pensions and other deferred compensation.
- Your net worth exceeds $2,000,000.
- Your average annual net income tax is $162,000 or greater.
- You have not complied with all of your US tax obligations over the last five years.
Let’s assume you are a covered expatriate. You will need to calculate the gain (or loss) on the ‘deemed sale’ of your worldwide assets at fair market value (FMV) the day before the expatriation date.
Say you had a gain. This would be reported on form 8854, and you would apply the available ‘exit tax exclusion’ ($699,000 for 2017) against these gains. Any remaining gain would be reported on your final US return, as long or short-term capital gains. For example:
- Assume you owed stock with a value of $2m and a house with a value of $1m, you would have a total asset value of $3m
- And assume the cost (or Tax Basis) in the assets was $2m
- Your Deemed Gain on Sale would be $3m minus $2m = total of $1m.
- Your Reportable Deemed Gain After the Exit Tax Exclusion would be $1m – $699,000 = total of $301,000.
And ‘ineligible deferred compensation’ makes for an even bigger tax bite.
The most common form of ineligible deferred compensation is a non-qualified pension plan (e.g.,. most foreign pension plans).
This type of asset faces a current taxation under the exit tax rules, with no application of the exit tax exclusion mentioned earlier.
‘Eligible deferred compensation’ also exists. The most common form is a qualified US pension plan (like a 401K). The tax on this type of asset can be deferred from the exit tax, but only if specific rules are followed and forms are filed in a timely manner (30 days from expatriation).
Otherwise, it would be taxed in full on the final return – just like ineligible deferred compensation.
It’s not all bad news. Even if the asset or income tax test is met, you can avoid the covered expatriate status if you acquired at birth a dual nationality of the US and another country, and you continue to be a citizen and a tax resident of that country on the date of expatriation, and you are a resident of the US for not more than 10 out of the last 15 years.
Also, the December 2017 tax code provides relief in the form of an increased gift and estate tax exemption of $11,200,000 per person (starting in 2018). It is possible, with proper planning, to reduce or even avoid the exit tax altogether by utilizing this higher exemption amount.
We hope you have found this article useful and will share your new-found expatriation knowledge with your US citizen or green card holder family and friends.
The exit tax is not something to be taken lightly.
You can learn more about these issues by searching for ‘Internal Revenue Bulletin: 2009-45’.
An ounce of prevention is worth a pound of cure.
Submitted by PATRICK HOZA and NATALIA RAZHEVA
Patrick has 20 years’ experience with US individual expatriate taxation; including multinational programs, high net worth individuals, streamline/voluntary disclosure filings, and tax consulting. He has extensive knowledge in serving US expatriates in various issues.
Natalia has more than 10 years of experience with US individual, corporate and partnership tax, high net worth individuals, and tax planning. She is a CPA with an MS in Taxation and an MS in Accounting. Natalia specializes in international aspects of US taxation.