Expatriation can be a difficult decision. Maybe you are trying to find answers to some basic questions or just trying to find a guide to navigate the maze of legal procedures involved in expatriation. This eBook is designed to provide a basic overview of the process of expatriation to help you decide whether it is economically worthwhile to give up your US residency (or citizenship) and help reduce any potential tax liabilities which can pop up if you don’t plan ahead. We’ll skip most of the technical jargon, where possible, and lay out all the facts to help you make an informed decision.
Expatriation: what does it all mean?
Normally when we hear the word “expat” we think of the masses of 20-something Americans enjoying a semester abroad, couch surfing with other artistic types, searching for local brews, and a direction in life. In actuality, expatriation under American law refers to the formal process of giving up your citizenship or permanent residency (A.K.A. green card). It can be a bureaucratic and costly hassle; why do people bother? For a long time it really wasn’t much of an issue. Most people would just move to another country and never bother to renew their green card. But the times (and laws) they are a changing.
Nowhere to run to, nowhere to hide.
Over the last 5 years there has been a huge surge in people officially expatriating. Some of those people are just trying to pay less in taxes but many are encountering unexpected difficulties associated with US citizenship or resident status. Since 2010, the US Treasury and Justice Department has started to aggressively hunt out US residents with foreign bank accounts. Any foreign bank wanting to do business with the United States (pretty much everyone) is now required to disclose the names of their American (citizens and resident) account holders.
The idea behind the law was to catch all those rich tax scofflaws hiding their money in Switzerland where the IRS couldn’t find them. But for most US residents, the new law imposed a lot of confusing paperwork on anyone with a foreign “account.” Many foreign banks refuse to open new accounts for US residents because they don’t have the systems in place to fulfil their reporting obligations under the US laws. The types of foreign “accounts” these rules apply to can run the gamut from savings and checking accounts, to pensions, and even life insurance policies. Now every US citizen or resident with foreign “accounts” worth $10,000 or more, in aggregate, has to file a yearly FBAR form or risk paying a $10,000 penalty (possibly more). For a lot of people living abroad but still holding on to their US residency, the costs of filing and preparing taxes every year, in addition to the new reporting rules, has them wondering…
Expatriation is not just for citizens – at least not anymore. Since 1996, all long-term US residents who leave the country can be subjected to the dreaded status of “covered” expatriate. This legal regime can apply to rich and poor alike and imposes some very harsh penalties on the unwary. The US government doesn’t like it when people give up their US residency. The rules now presume that any would-be expatriate with a certain amount of assets ($2 million), or a high level of taxable income, is trying to escape paying taxes to the American government (see Eduardo Saverin). Of course, there will always be people who don’t appreciate paying taxes on their worldwide assets (see Boris Johnson) but the “covered” expatriate rules were drawn very broadly and risk catching a lot of people who don’t have much money but fail to follow the certification rules when they leave the country.
- Citizens who renounce their citizenship UNLESS:
they were born with dual citizenship, retain their other citizenship, are taxed in their other country of citizenship, and have not been a US resident for more than 10 of the last 15 years before renouncing their citizenship,
OR, you relinquish citizenship before age 18 ½ and were not a US resident for more than 10 years
- Long term residents of the US (green card holders) for at least 8 of the last 15 years
and that person has
- more than a specific level of net income tax liability each year, for the previous 5 years (an amount indexed for inflation - $157,000 in 2014)
- OR more than $2 million in assets (no inflation adjustments here I am afraid)
- OR fails to certify compliance with federal tax obligations for the five previous years (normally, by filing form 8854)
In a rich man’s world.
Eduardo is a young man with promise and drive. Born in Brazil, he becomes a naturalized US citizen. While attending Harvard University, he and a friend create a new social media website for people at the college. Their website is incredibly popular and grows into a business worth billions of dollars. Eduardo has a falling out with his college friend and the two part ways. The company continues to grow and plans to go public. Eduardo moves to Singapore and decides he doesn’t really want to pay millions in tax to the US government for his share of the company so he decides to renounce his US citizenship. By expatriating now Eduardo expects to save more than $500 million dollars in future US taxes.
I fought the law and the law won.
Little Boris was born in New York City to British parents. By being born in America he was also a US citizen too. The family soon left New York and young Boris grew up in England. He became a journalist. In 1999 Boris bought a house in London where he happily lived with his family. As time passed the value of that home skyrocketed. In 2008 Boris got a great new job as the mayor of London and decided to move to a much nicer house. Boris didn’t maintain much contact with the United States but the country and its tax authority remembered him fondly so when they heard he had sold his house AND earned a nice profit on that London home, they called to remind Boris that, as a US citizen, he would have to pay the United States government a large tax bill for the sale of his London home. Boris was seriously displeased. He ranted and railed against the tyrannical IRS but, in the end, the Lord Mayor was forced to pay an estimated $150,000 before he was permitted to renounce his US citizenship. Boris was actually a lucky guy; he was able to avoid covered expatriate status being born with dual citizenship and residing in the UK for most of his life. I don’t imagine he found that news particularly comforting.
Here’s a good example: Aniko gets a job with GM in Michigan. She works there for 9 years but can’t stand the harsh winters and decides to return to her native Budapest. She files her taxes for the last year she lives in the US but stops filing after she flies home. She doesn’t inform the immigration people that she is formally expatriating and just allows her green card to expire. Five years later, Aniko decides she wants to start collecting the pension she earned while working at GM. When she calls the pension administrator to get her money transferred, she finds out that – because she didn’t submit form 8854 to certify she had paid all appropriate taxes for the five years before she left the US – she is now a “covered” expatriate and the pension plan is required to withhold 30% of her pension payments. Under the existing law, there is no way she can correct her mistake. Once covered, always covered.
Timing is everything.
When did Aniko actually expatriate? Here the IRS rules refer back to the immigration code which says you are a long term resident until A) you are administratively/judicially stripped of your green card, or, B) you move to another country which has a tax treaty with the US, you don’t waive the benefits of that treaty, and notify the IRS on form 8833 or 8854. The year Aniko moved back to Hungary (which has a tax treaty with the US) she should have filed form 8854 with her tax return. If she moved to Peru, a country with no US tax treaty, then she might be able to file back US tax returns and argue she didn’t legally expatriate until the date she filed form 8854, so no covered expatriate status. Odd result but theoretically possible. The lesson from this example is: file form 8854 the year you leave!!!
Your decision whether to remain a US resident or not should be based on personal circumstances and not financial motivations. Unfortunately, all US residents are required to file a yearly tax return and the costs associated with accurately filing can be tremendously high. If you happen to have foreign income or assets your return might be accompanied by one or all of the following forms: form 8938 for foreign financial accounts (same accounts, different form); form 3520 for foreign trusts of gifts received; 8621 for each foreign mutual fund; 8865 for foreign partnerships; and either form 1116/2555 for the foreign tax credit or foreign income exclusion. You can try to prepare these forms on your own using commercial tax software but there is a real risk you do not fill out the forms correctly or miss filling out a required form. Alternatively you could hire a CPA to file the returns but this can become quite costly.
Here are some of the questions we normally ask clients to determine whether they might qualify under the “covered” expatriate test
- When did you first arrive in the US and under what type of visa
- When were you planning to end your US residency?
- Have you been a permanent resident for 8 of the last 15 years?
- What is the value of all your assets now and when you first became a resident?
- Do you pay more than $150,000 in income tax each year?
- Do any of your family members currently live in the US or plan to in the future?
- Have you filed taxes for the last 5 years?
This is a land of confusion.
The tax code and immigration code are not always in sync. As Aniko learned, the tax code requires all expatriates who want to avoid being “covered” to certify that they have paid all necessary taxes and filed the appropriate forms for the past five years. If you fail to do this within a year of leaving the country then you get “covered” by a host of exit tax provisions which can include: a tax on all your assets, higher withholding for US pensions, and the highest rate of gift tax (currently 40%) on any money you might leave for American friends and family in the distant future (after accounting for the estate tax exclusions). The immigration code says you effectively expatriate the day you leave the country. For most people, the year they leave the US with the intention of permanently expatriating it is important to file both a 1040 and a 1040NR (where necessary) PLUS the all-important form 8854 to certify they have been fully compliant with all tax laws for the past five years. It is also prudent to file a form I-407 with the state department to certify the exact date you are expatriating or you can also mail your green card back to a local consulate (with appropriate forms).
It won’t be home no more.
For US citizens the process of expatriation (renouncing citizenship) can be more complex. Consulates abroad have been inundated with requests by dual citizen US passport holders looking to renounce their citizenship. Fees have jumped from $450 to $2,350 and it can still take months to get an appointment with a consular official. Of course, expatriating citizens are also required to file the same form 8854 attesting to the fact that they have paid and filed taxes for the previous 5 years.Even after you make certain to file all your taxes, pay the fees, and go through the interview process, there is still the issue of the dreaded exit tax which applies to all “covered” expatriates.
More money, more problems.
Most people will be “covered” under the asset test. It may seem like a lofty goal to have $2 million in assets but for those lucky few it can still pose a real burden. The IRS looks at everything you own, pretends you are selling it all, and then imposes a tax on the phantom proceeds over a certain exclusion amount ($690,000 in 2014). It doesn’t matter if you can actually sell the assets (or want to). But hey, if you can’t afford to pay the tax all at once they are willing to put you on a payment plan… with interest. If you came to the US with assets in tow, those assets are still included in the covered expatriate test. The US government really doesn’t like losing residents/revenue. Any possible tax on those assets will only include any gains made from the date a person becomes a US resident.
If you are a current US green card holder considering expatriation and you aren’t “covered” by the income or asset tests, are you home free? You won’t be covered by the exit tax if (to belabor the point) you file form 8854 with your last tax return as a US resident. After you have left the country there are a couple additional tax-related steps you need to take in order to ensure you fully comply with US laws. Even non-resident aliens (the rather harsh way the IRS describes non-US people) have to pay taxes on US source income. That can be done by filing a 1040NR but aliens only have to file these returns if they have US income which hasn’t already been taxed. A much easier way to get your US taxes paid without filing another return (ever again, possibly, maybe) is to ensure proper withholding on all US income sources, for example, by sending your US pension fund using form W-8 BEN. The parties receiving your form will then withhold the appropriate amount of US tax. If you aren’t sure whether your income is subject to US taxes you can look up the appropriate source rules in IRS publication 515.
One less problem.
There are also a lot of clever ways to avoid getting “covered” which can help you and your family hold onto existing assets and avoid the exit taxes. If you qualify under the income test, you can take steps to reduce your taxes for certain years through charitable giving (the Rock and Roll Hall of Fame is a 501c3 non-profit!). Many of the tools for reducing your current assets lie in the realm of estate and gift planning. The trick is to plan ahead and consult with an attorney to determine the best ways retain your wealth, reduce any further US tax liability and end your relationship the the IRS on a high note.
When the music stops.
At Freeman Tax Law, we advise clients on the best choices to make based on your individual circumstances. We are providing this free eBook, not to frighten you away from the concept of expatriation, but to help you understand that certain steps must be taken to ensure full compliance with US tax rules before you take that big step. With planning and preparation you can avoid being labeled a “covered” expatriate and ensure you don’t get stuck with the IRS’ version of the long goodbye.
Break it on down.
To illustrate how the exit tax might apply take the following example:
Sharon is a dual US/Canadian citizen. She lives in Vancouver and is tired of paying a CPA every year to file a tax return in the US so she decides to relinquish her US citizenship and officially expatriate on December 30, 2014. Sharon has only two assets: her condo in Vancouver and a house in San Francisco. The condo was recently purchased for $300,000 dollars. The house in San Francisco is owned outright. She inherited it from her grandfather more than 30 years ago when it was worth $100,000. Thanks to the influx of Facebook workers to the neighborhood, the house is now worth $5 million dollars. Sharon’s assets qualify her as a covered expatriate under the asset test. The condo is new and so there is no gain in value so no tax to be paid. The house however has increased in value by $4,900,000. At the top capital gains tax rate, the taxable income from selling the house immediately would be $980,000. Ignoring all credits and exemptions (and the fact that she can’t actually sell the property until her tenants’ lease runs out) Sharon will owe $290,000 in tax payable by April 15 of 2016.
So why has Treasury and the IRS foisted all these new reporting laws on US residents? A lot of these forms, like the FBAR, have been around for decades but few people knew about them and they were mainly used as a tool to fight money laundering and tax evasion. The only recent change has been the imposition of some stiff new penalties for “non-willful” failures to disclose ($10k per offense - ouch). Some regulations came out of the Patriot Act and the fight against terrorism. Others, like FATCA (Foreign Account Tax Compliance Act) came about after revelations from the UBS tax evasion controversy when a Swiss banker provided evidence of American’s who hid money in Switzerland to avoid paying taxes. The US government has known that a lot of its citizens and residents were not paying taxes on all their income. After many years of relying on self-report, the IRS is taking a stronger line.
Goodbye, so long.
So who has actually gone through the expatriation process? Every year the Treasury Department publishes a list in the Federal Register of persons “who have chosen to expatriate.” That list is compiled from all the people who file form 8854, lose their citizenship, or have their green card revoked. Some of the names you might recognize from years past include: Tina Turner, Yul Brynner, W.E.B Du Bois, Terry Gilliam, Jet Li, the former Queen of Jordan, and Elizabeth Taylor (although she later applied to have her US citizenship reinstated). The list of more recent expatriates can be found here: https://www.federalregister.gov/quarterly-publication-of-individuals-who-have-chosen-to-expatriate