U.S. Taxation: Expatriation
by George Gonzalez
As a U.S. citizen you are subject to taxation of worldwide income regardless of where you live. U.S. citizens who reside on a full-time basis outside of the U.S. are entitled to some tax breaks. In separate articles in these web pages I discuss three of those tax breaks: the Foreign Earned Income Exclusion, the Housing Exclusion, and the Foreign Tax Credit.
One might say that the ultimate break from the U.S. tax system is expatriation, i.e., renunciation of U.S. citizenship (or renunciation of permanent residency). Renunciation is a serious action that should only be taken after careful consideration of its many ramifications. Some ramifications are, of course, tax related, but many others are non-tax related, e.g., financial costs of the renunciation process, immigration status, travel privileges, employment alternatives, residency options, etc.
If you are seriously considering renunciation, then you will want to inform yourself of the rules surrounding the “expatriation tax”. The key aspects to this tax are: (1) to whom do the rules apply; (2) the thresholds that determine whether the expatriation tax is levied; and (3) how the tax operates if it is levied.
To Whom the Expatriation Tax Rules Apply
The expatriation tax provisions apply to U.S. citizens who have renounced their citizenship and to long-term residents who have ended their U.S. resident status for federal tax purposes.
A U.S. citizen will be treated as relinquishing their U.S. citizenship on the earliest of four possible dates:
- the date the individual renounces his or her U.S. nationality before a diplomatic or consular officer of the United States, provided the renunciation is subsequently approved by the issuance to the individual of a certificate of loss of nationality by the U.S. Department of State;
- the date the individual furnishes to the U.S. Department of State a signed statement of voluntary relinquishment of U.S. nationality confirming the performance of an act of expatriation specified in paragraph (1), (2), (3), or (4) of section 349(a) of the Immigration and Nationality Act (8 U.S.C. 1481(a)(1)-(4)), provided the voluntary relinquishment is subsequently approved by the issuance to the individual of a certificate of loss of nationality by the U.S. Department of State;
- the date the U.S. Department of State issues to the individual a certificate of loss of nationality; or
- the date a U.S. court cancels a naturalized citizen’s certificate of naturalization.
Long-Term Residency Termination:
A long-term resident ceases to be a lawful permanent resident if:
- the individual’s status of having been lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with immigration laws has been revoked or has been administratively or judicially determined to have been abandoned, or
- the individual:
- commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country,
- does not waive the benefits of the treaty applicable to residents of the foreign country, and
- notifies the IRS of such treatment on Forms 8833 and 8854.
“Long-term resident” means any individual (other than a citizen of the U.S.) who is “a lawful permanent resident of the U.S. in at least eight taxable years during the period of 15 taxable years ending with the taxable year during which the event described in paragraph (1) occurs.”
Expatriation Tax Thresholds
Not all U.S. citizens who renounce and not all long-term residents who end their residency are subject to the expatriation tax. The expatriation tax kicks in only if you meet one of two threshold tests. One of the tests is an income test, the other one is a net worth test.
Income test: You meet this test if your average annual net income tax liability for the five years ending before the date of expatriation is more than a certain amount. The amount changes from year-to-year; as of this writing, the threshold amount is $190,000.
Net worth test: You meet this test if your net worth is $2,000,000 or more on the date of expatriation.
Catch-all exception: A requirement of U.S. citizens who renounce and long-term residents who end their residency is to include IRS Form 8854 with the U.S. income tax return filed for the year of expatriation. The purpose of the form is to document and certify that the taxpayer does not have any outstanding taxes due and provides information on whether one or both of the income and net worth tests described above have been met. If Form 8854 is not filed, then the expatriation tax is applicable even if the threshold tests are not met. Thus, it is critically important to file Form 8854 when you expatriate.
How the Expatriation Tax Works
The expatriation tax is, conceptually, fairly uncomplicated. It is a “mark-to-market” rule that results in the recognition for tax purposes of unrealized gains on losses on property. The tax calculation assumes that you sold your property for its fair market value (FMV) on the day before your expatriation date. The rule applies to most types of property on the date of your expatriation, however, there are exceptions for some types of property:
- Eligible deferred compensation items
- Ineligible deferred compensation items
- Specified tax deferred accounts
- Interests in nongrantor trusts
There are specific rules for these exceptions, some related to tax withholdings on these items. Those details are beyond the scope of this article.
It is possible to defer payment of the expatriate tax on the deemed sale of property. The following technical rules, if complied with, allow you to defer payment:
- You make the election on a property-by-property basis.
- The deferred tax on a particular property is due on the return for the tax year in which you dispose of the property.
- Interest is charged for the period the tax is deferred.
- The due date for the payment of the deferred tax cannot be extended beyond the earlier of the following dates.
- The due date of the return required for the year of death.
- The time that the security provided for the property fails to be adequate. See item (6) below.
- You make the election in Part II, Section D—Deferral of Tax.
- You must provide adequate security (such as a bond).
- You must make an irrevocable waiver of any right under any treaty of the United States that would preclude assessment or collection of any tax imposed by section 877A.
Paying or Deferring the Expatriation Tax
The expatriation tax is calculated on the previously mentioned IRS Form 8854. Electing to defer payment of the tax is also made on this form.
If you are considering expatriation, it would be a good idea to complete a draft Form 8854 ahead of time so that you know what it involves, and to estimate what your expatriation tax would be if and when you expatriate.