For those who have a second citizenship, they may choose to free themselves from their US status and tax filing obligations. US citizens can renounce their citizenship and Green Card holders can surrender their Green Card. Both of these routes are considered an expatriation for US tax purposes.
Although the idea of no longer being subject to US tax may sound like a way to simplify your affairs, careful consideration should be given to potential exit tax charges once going down the irrevocable route of expatriation.
Exit tax for Covered Expatriates
Covered Expatriates (defined below) may have to pay an ‘exit tax charge’ in order to give up their US status. This is a Capital Gains Tax calculated on the deemed sale of worldwide assets (valued on the day before the expatriation). Although the first $767,000 of the deemed gains are not taxed, the exit tax charge may lead to cash-flow issues as cash proceeds have not been received.
Who is a Covered Expatriate?
Before expatriation, US Citizens or individuals who have held a Green Card for at least seven out of the last 15 years (known as long term permanent residents), should determine if they are a ‘covered’ or ‘non-covered’ expatriate.
A US citizen or long-term permanent resident is a covered expatriate if any of the three tests below are met:
- Average annual net US income tax liability for the five years preceding the year of expatriation exceeds $178,000
- Worldwide net worth (including home) on the day of expatriation equals $2 million or more
- Unable to certify via Form 8854 that US tax filings (including foreign reporting forms and FACTA requirements such as Foreign Bank Account Reports) have been fully satisfied for the five proceeding years.
It should be noted that special rules apply to deferred compensation (e.g., company stock options), specified tax-deferred accounts (e.g., IRA, 401K, 529 plans) and interests in non-grantor trusts, meaning covered expatriates may not realise they have breached the $2m worldwide asset test before expatriating.
Non-covered expatriates are not subject to the exit tax and can expatriate free of charge.
Covered Expatriate: The Exceptions
A covered expatriate is not subject to the exit tax charge if they are a dual national from birth, continue to be a citizen of their second country and are also taxed as a resident of that country.
Alternatively, US citizens who are under the age of 18 ½ or over the age of 18 ½ but have not been US tax resident for more than 10 taxable years can relinquish their citizenship tax free.
Planning Opportunities
Careful planning before expatriating may reduce (or eliminate) the exit tax charge for covered expatriates. For example, gifting of assets to individuals/charitable organisations can reduce a covered expatriate's worldwide net worth to under $2m, meaning they are no longer subject to the exit tax charge. However, individuals will need to consider if other US or local income or gift tax charges will be triggered when making these gifts.
How to Expatriate
Once it has been determined an individual is a qualified covered or non-covered expatriate (and the exit tax charge has been calculated, if applicable), individuals can formally revoke their US status.
For US citizens, they must attend an appointment at a US embassy or consulate, pay a fee of $2,350 and request a Certificate of Loss of Nationality.
For Green Card Holders, Form I-407 (Record of Abandonment of Lawful Permanent Resident Status) or a written letter stating their intention to expatriate should be submitted to the consular office. In both cases, the Green Card should be enclosed with the submission and formally returned to the US Citizenship and Immigration Services. Simply letting your Green Card expire does not negate US tax responsibilities and, as a long-term resident, individuals must take proactive steps to ensure they are no longer subject to US taxes.
Post Expatriation
Following the year of expatriation, individuals will no longer have to comply with US tax filing obligations of a citizen and will be outside the scope of the US Estate and Gift Tax Rules (although special rules apply if they still hold US situs assets). As a non-US person, visa and immigration rules will need to be considered going forward before entering the US for a holiday or business trip. Considering the tax and immigration consequences of expatriation, professional advice should be considered to fully understand the implications of these actions.
