- 1 Relinquishing Permanent Residency and US Taxes
- 2 Pre-Planning Before Renouncing
- 3 Who is a Long-Term Lawful Permanent Resident
- 4 Exit Taxes When You Renounce
- 5 IRS Forms: 1040/1040NR/Sailing Permit/8854
- 6 Exceptions to Exit Tax
- 7 What Income Gets Taxed When You Exit
- 8 Mark-to-Market
- 9 Specified Tax Deferred Accounts
- 10 Ineligible Deferred Compensation
- 11 Eligible Deferred Compensation
- 12 Trusts
- 13 Post-Expatriation Taxes
- 14 Covered Expatriate Taxes
- 15 Annual Expatriation Statement
- 16 Golding & Golding: About Our International Tax Law Firm
Relinquishing Permanent Residency and US Taxes
It used to be, that only US citizens (birth or naturalized) could become subject to the expatriation tax rules. Then, about 20-to-25 years ago the US government modified the law so that it would also include a long-term lawful permanent resident (LTR). In other words, when a person is a long-term lawful permanent resident then they may become subject to the Internal Revenue Service’s updated exit tax similar to that of a US citizen. Unlike US citizens, only certain permanent residents are considered to be long-term lawful permanent residents – which is very important, because if a permanent resident does not qualify as a long-term lawful permanent resident then they are not subject to any potential exit tax consequences. When a person is an LTR and relinquishes their Green Card they may become subject to an exit tax at the time they expatriate if they are considered a covered expatriate and if they have certain types of income that fall into the different exit tax categories such as mark-to-market gains and specified tax-deferred accounts. While the immigration process of relinquishing a Green Card is simpler than renouncing US citizenship — the tax implications can be just as complicated. This article is designed to provide insight into the basics of each step in the renouncing process.
Pre-Planning Before Renouncing
It is important to note that once a person relinquishes their green card, they cannot take that step back. That is not to say they cannot become a US person at a later date, but from a tax perspective, the key point in time is the day before the LTR formally expatriates. Thus, it is important for the taxpayer to do all the necessary tax legwork, analysis, and evaluation before formally renouncing. Generally, a Lawful Permanent Resident gives up their Green Card by submitting a Form I-407 to USCIS.
Who is a Long-Term Lawful Permanent Resident
The main tax form for U.S. Citizens and Long-Term Residents to complete at expatriation is the IRS Form 8854. The definition of long-term resident is summarized well for the instruction of Form 8854 as follows:
“For purposes of this subsection, the term “long-term resident” means any individual (other than a citizen of the United States) who is a lawful permanent resident of the United States in at least 8 taxable years during the period of 15 taxable years ending with the taxable year during which the event described in paragraph (1) occurs.”
We have a separate, more detailed article about determining Long-Term Lawful Permanent Resident status.
Exit Taxes When You Renounce
One of the biggest headaches for LTRs when they renounce their PR status is the issue of the exit tax. We have authored several articles on all matters involving exit taxes, but we wanted to provide an introductory summary of some of the basic considerations to be aware of if you are considering giving up your green card. The most important thing to keep in mind is that the exit tax is not a wealth tax. In other words, while one person can exit the United States and be worth $50 million and have no exit tax, another person with a much lower net worth may have a significant exit tax. It is based on the type of potential exit tax income they will have to report in their final year, which we will go through below. As provided by the IRS:
Expatriation on or after June 17, 2008
If you expatriated on or after June 17, 2008, the new IRC 877A expatriation rules apply to you if any of the following statements apply. Your average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation ($162,000 for 2017, $165,000 for 2018, $168,000 for 2019, and $171,000 for 2020. Your net worth is $2 million or more on the date of your expatriation or termination of residency. You fail to certify on Form 8854 that you have complied with all U.S. federal tax obligations for the 5 years preceding the date of your expatriation or termination of residency. If any of these rules apply, you are a “covered expatriate.”
A citizen will be treated as relinquishing his or her 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.
For long-term residents, as defined in IRC 7701(b)(6), 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. IRC 877A imposes a mark-to-market regime, which generally means that all property of a covered expatriate is deemed sold for its fair market value on the day before the expatriation date.
Any gain arising from the deemed sale is taken into account for the tax year of the deemed sale notwithstanding any other provisions of the Code. Any loss from the deemed sale is taken into account for the tax year of the deemed sale to the extent otherwise provided in the Code, except that the wash sale rules of IRC 1091 do not apply.
IRS Forms: 1040/1040NR/Sailing Permit/8854
In general, when a person gives up their LTR status, they will have to file a final Form 1040 tax return for the year that they renounced. Accompanying Form 1040 may be several other US tax forms as well, such as a Form 1040-NR for the portion of the year that they are a non-US person, a Form 8854 which is the expatriation statement, and possibly a sailing permit.
Exceptions to Exit Tax
Not everybody who is an LTR can even become subject to the exit tax, even if they would otherwise be a covered expatriate. That is because there are certain exceptions and limitations for some taxpayers who meet one of the exceptions for not having to pay exit taxes. As provided by the IRS:
Lawful permanent resident.
You are a lawful permanent resident of the United States if you have been given the privilege, according to U.S. immigration laws, of residing permanently in the United States as an immigrant. You generally have this status if you have been issued an alien registration card, also known as a green card, and your green card hasn’t been revoked or judicially or administratively determined to have been abandoned. However, you are also no longer treated as a lawful permanent resident if you
(1) commenced to be treated as a resident of a foreign country under the provisions of a tax treaty,
(2) did not waive the benefits of such treaty, and
(3) notified the IRS of the commencement of such treatment. See Regulations section 301.7701(b)?7 for information on related filing requirements.
What Income Gets Taxed When You Exit
The exit tax calculation is complicated. That is because while most people presume that exit tax only involves potential mark-to-market gain on assets that grew in value while the person was a Permanent Resident, there are various other categories of potential exit tax as well. This includes specified tax-deferred accounts — such as a traditional IRA, ineligible deferred compensation — such as foreign pension plans, and ownership of certain domestic and foreign trusts. In addition, if a person has restricted stock and other deferred compensation that is also grossed up into the value and potentially subject to exit tax even though the assets have not been fully vested. Let’s go through some of the basics of the different categories of income that may become subject to exit tax by using examples:
David is a US Permanent Resident who has stock that he acquired for $500,000 — 20 years ago while he was a Permanent Resident. At the time David is going to relinquish his Green Card, the value of the stock is worth $5 million. Noting, that although David has no intention of actually selling the stock, he will still have to pay an exit tax on the phantom mark-to-market and that would occur at the time he ‘pretend sells’ the stock. The sales price is based on the Fair Market Value the day before he formally expatriates.
Specified Tax Deferred Accounts
Michelle is a Permanent Resident who has a significant amount of money in a traditional IRA. She is a covered expatriate and so the value of the traditional IRA account is included as income on her final tax return. If it was a Roth IRA instead of a traditional IRA, then it may not be subject to exit tax — presuming that the taxpayer meets the requirements for age and time in the investment.
Ineligible Deferred Compensation
Scott is a Permanent Resident who worked overseas in a foreign country for many years (while he had the PR status and did not make any treaty elections). He has a significant amount of deferred foreign pension. Since the pension is not US based or otherwise qualified under US tax law it is considered ineligible deferred compensation. As a result, the value of the foreign pension is included as income on Scott’s final tax return, even if Scott does not receive the income at that time and even if Scott was to receive that income tax-free under the foreign country’s tax laws.
Eligible Deferred Compensation
Eligible deferred compensation such as a 401(k) is treated differently. While the value of the 401(k) is used to determine whether the taxpayer may meet the net worth test under the covered expatriate analysis, the taxpayer is not subject to an exit tax on eligible deferred compensation at the time she exits the United States. Rather, at a future date when she starts receiving distributions, she will have 30% taxes withheld from each distribution. At the time she formally expatriates, she must irrevocably waive the right to claim treaty benefits to reduce the withholding on those 30% taxes (Form 8854).
If a taxpayer has an ownership interest in a US or foreign trust, the value of the trust is grossed up as part of the potential exit tax. Trust exit tax rules are very complicated and can be impacted by whether or not it is a grantor trust or a non-grantor trust.
After a person formally gives up their PR status, they are no longer considered a US person for tax purposes. Therefore, for tax purposes, they are treated as nonresident aliens (unless they again become a US Person, noting Taxpayers should be cognizant of the Substantial Presence Test rules). As a result, they only pay tax on their US-sourced income. ECI or Effectively Connected Income is taxed at progressive tax rates. FDAP Fixed, Determinable, Annual, and Periodic income is taxed at a straight 30%, although the taxpayer may be able to rely on a tax treaty — if one is available between the country the taxpayer lives or resides and the United States — that reduces or eliminates withholding. Likewise, the other non-resident alien tax rules also apply so that items such as Capital Gains and Interest are generally not taxable to a Non-Resident Alien.
Covered Expatriate Taxes
One other tax item to keep in mind for Taxpayers who renounce but are deemed as Covered Expatriates is that there may be additional tax implications after they expatriate. Not only do some tax treaties even limit the tax benefits for people who are considered covered expatriates but there are also gift/estate tax implications as well. For example, if a Covered Expatriate wants to give a gift or a bequest to a US person, the US person is required to file paperwork and pay tax on the gift. And, the US person reports the money on Form 708 — although that form has not actually been published yet.
Annual Expatriation Statement
When an expatriate still has certain US investments such as deferred compensation after they give up their PR status, they may be required to continually file an annual Form 8854 and identify whether any distributions have been made to them — and other related issues.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure and how the Substantial Presence Test works. Contact our firm today for assistance with getting compliant. href=”https://www.goldinglawyers.com/contact-us-3/”>Contact our firm today for assistance.