Things to Know before Terminating your U.S. Citizenship or Permanent Residency Status
Céline Couillaut, Tax Principal
There may be many reasons for U.S. citizens to want to renounce their citizenship or for long-term U.S. residents (“green card” holders) to end their U.S. residency (both known as expatriation), but before taking the leap there are some things they should know. While the number of people renouncing their citizenship or permanent residency is growing year after year, doing so to simply avoid U.S. taxes will not necessarily produce the expected result.
The Federal government requires a final income tax return to be filed for the year of expatriation, alongside Form 8854, the Initial and Annual Expatriation Statement, and could require you to pay an “exit tax.” This exit tax is computed as if all your assets were sold for their fair market value on the day before your expatriation date (the “mark-to-market” regime). If you are considered a “Covered Expatriate” you may be required to pay this tax.
Who is a Covered Expat?
You are a covered expatriate if any of the following statements apply:
- You fail to certify that you have filed (and filed properly) your U.S. income tax returns for the five tax years preceding the date of expatriation.
- Your average annual net income tax liability for the five tax years ending before the date of expatriation is more than the amount listed below:
- $162,000 for 2017
- $165,000 for 2018
- Your net worth (including retirement accounts, bank accounts, and value of all property inside and outside of the U.S.) is over $2 million on the date of expatriation (note that for married taxpayers, each spouse’s net worth is calculated separately from the other).
What assets are included in the calculation of the deemed gain?
The answer to this is simple, most worldwide assets are included as part of the calculation if owned on the day before expatriation. It requires a valuation of all assets, inside and outside of the U.S., at fair market value. Note that the mark-to-market regime does not apply to certain types of property, including retirement or annuity plans (e.g. 401(k) or 403(b) plans), foreign pensions, deferred compensation (e.g. deferred bonus or stock options), individual retirement accounts (IRAs), certain education and health savings accounts, and interests in non-grantor trusts. Instead, a withholding tax may apply on distributions from the account, or an amount equal to the present value of the account will be treated as received on the day before expatriation and taxable as ordinary income.
Some additional things to know:
- All deemed gain retains its original character. For instance, long-term capital gain property is taxed at favorable rates, ordinary gains at ordinary income tax rates, etc.
- The amount of gain that would otherwise be includible in gross income is reduced (but not below zero) by an exemption of $699,000 in 2017 ($713,000 in 2018). Note that for married taxpayers, each spouse can claim the maximum exemption. The exemption only applies to deemed capital gains, and not against the income from a deemed distribution of an IRA and/or other tax-deferred account.
- Deemed dispositions of foreign property will not generate a foreign tax credit.
- A covered expatriate may elect to defer tax due on the deemed sale of assets. Tax will be deferred until the property is actually sold or the taxpayer dies. However, security (such as a bond) must be provided, interest is charged for the period the tax is deferred, and treaty rights must be irrevocably waived if they preclude assessment or collection of the exit tax.
In conclusion, while you may see a benefit from renouncing your U.S. citizenship or permanent residency status, there are also consequences that come along with it. Permanently giving up your citizenship or permanent residency is an irrevocable act. Travel into the United States after expatriation is restricted, and renouncing citizenship may be a lengthy legal process.
If you would like to learn more about the process of expatriation, please contact Stuart Lyons or your BNN advisor at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.