The US Federal Register reveals a record number of expatriations in recent years, topping over 1,000 a quarter. What is often overlooked are the potential tax ramifications of expatriating. Are all expatriates the same? What is the US exit tax? Which expatriates are impacted and why? The answers to these questions are often surprising…
An “American expat” is not the same as an American who expatriated. The former includes the likes of Ernest Hemmingway, F. Scott Fitzgerald, Johnny Depp, Madonna, Angelina Jolie and Brad Pitt—basking in their creativity abroad or escaping American paparazzi. The latter includes the likes of Facebook founder, Eduardo Saverin, the pardoned Marc Rich and his wife Denise Rich, and Ted Arison.
With increasing international tax compliance requirements causing US taxpayers an ever mounting burden, many of them are concluding that the US passport or Green Card is no longer worth it. They may not be relinquishing their right to a life in the United States just to avoid paying substantial amounts of tax, as they may be living, or end up living, in a country with tax rates higher than in the United States. They may instead simply not feel an emotional tie to the United States. Whatever their reasons, these “expatriots” (as some in Congress would label them), often, sometimes inadvertently, trigger the US exit tax.
THE EXIT TAX APPLIES TO BOTH FORMER US CITIZENS AND LONG TERM RESIDENTS
Strikingly, the US exit tax regime affects not only US citizens giving up their US nationality, but also lawful permanent residents (Green Card holders) who may have been in the United States for relatively brief employment opportunities. The Green Card holders impacted are those that are considered long-term permanent residents (LTRs).
An LTR is an individual who has been a Green Card holder of the United States in at least eight of the last 15 tax years, ending with the year the individual expatriates. If an LTR files a Form 8833, he or she will be deemed to have expatriated and may trigger the US exit tax. This rule excludes any year in which the individual was treated as a resident of a foreign country under a tax treaty and did not waive treaty benefits, i.e., the individual filed a Form 8833 claiming treaty country residency, with a Form 1040-NR while they were not considered an LTR.
WHO IS A COVERED EXPATRIATE?
Under current US tax law, certain high net worth individuals who relinquish their US citizenship or LTR status are considered covered expatriates (CEs) and subject to an exit tax on the phantom gain from the deemed sale of their worldwide assets.
To be a CE and subject to the US exit tax rules, the expatriate needs to fall into one of the following three categories:
- Individuals with an average income tax liability in excess of US$160,000 (as of 2015, as indexed for inflation) for the five tax years prior to the expatriation date.
- Individuals with a net worth of US$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, mutually exclusive, categories would make an individual a CE and subject him or her to the US exit tax rules.
Not all expatriates, however, are CEs. The term “expatriate” for exit tax purposes includes individuals who are US citizens who relinquish their citizenship, or LTRs relinquishing their Green Cards. As explained above, however, the term CE includes only individuals that fall into one of the three categories above when he or she expatriates.
Importantly, the application of the exit tax has no bearing on an expatriating US citizen or LTR to file a Form 8854 Initial and Annual Expatriation Statement with his or her final US tax return. Until the US citizen files a Form 8854, the individual is not considered an expatriate for US tax purposes, and is still subject to US worldwide taxation as if he or she were still a US citizen.
WHAT IS THE US EXIT TAX?
A CE who expatriates in 2015 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 US income tax on the portion of that phantom gain that exceeds US$690,000 (as of 2015, as indexed for inflation). Special rules apply to certain deferred compensation accounts, non-grantor trusts and certain other tax-deferred accounts, such as Individual Retirement Arrangements and 401Ks.
The “expatriation date” for a US citizen is the date on which the individual relinquishes his or her US citizenship. The rules for calculating this date bear some similarity to, but are not the same as, the applicable US immigration rules. The expatriation date for an LTR is the date on which the individual ceases to be a lawful permanent resident of the United States.
WHAT OTHER TAXES APPLY TO COVERED EXPATRIATES?
Beyond the US exit tax, the perpetual succession tax on any gifts or bequests that a CE makes to a US person should also be considered. Section 2801 of the Internal Revenue Code imposes a succession tax, payable by the US individual or US trust recipient, on gifts or bequests from a CE. To the extent that a gift or bequest from a CE to a US recipient exceeds s y a mark on n of the triate’s sets. the US$14,000 annual gift exclusion (the 2015 amount) (or qualifies for the marital or charitable deduction), the recipient is subject to US taxation at the highest marginal estate or gift tax rate (currently 40 per cent). There is no sunset provision, so this tax applies in perpetuity until after the CE has died and his or her estate has been closed.
Under Announcement 2009-57, the Internal Revenue Service intends to issue guidance on Section 2801 and the new Form 708 to report the receipt of gifts and bequests subject to Section 2801. Importantly, until this guidance is issued, the due date for reporting and paying the 2801 tax imposed has not yet been determined. Although the due date for reporting and paying the 2801 tax has not been finalised, the existence of this provision may cause planning problems for CEs who plan to leave their assets to certain US persons.
ESCAPING COVERED EXPATRIATE STATUS
Certain dual nationals and certain minors may avoid CE status. All expatriates can avoid CE status if they can escape falling into one of the three CE categories. All individual expatriates must, however, certify that they are US tax compliant, even if they satisfy one of the exceptions. Fortunately, given the outcrop of US voluntary disclosure programs, non-compliant individuals may more readily become compliant, so they can then expatriate without triggering the US exit tax.
The US exit tax rules are complicated and often overlooked when an individual wishes to expatriate. Regardless of the motive, expatriation should not be a rash decision, especially given the heavy consequences of the exit tax and perpetual succession tax. With careful planning and bespoke advice at the front end, individuals can navigate these rules and tailor a solution that fits their cross-border needs. So, if they wish to join the thousands of expatriate Americans, they can do so knowing how much it will cost them.