- 1 Exit Tax For Legal Permanent Residents
- 2 What is the purpose of the Expatriation Tax?
- 3 Exit Tax Avoidance Example
- 4 Is the Expatriation Tax fair?
- 5 The IRS does not Care if it is Fair…
- 6 Are you a Long-Term Resident?
- 7 What does it mean to be a “Covered Expatriate”
- 8 Am I a Covered Expatriate?
- 9 How does Expatriation Work?
- 10 Penalties
- 11 Significant penalty imposed for not filing Expatriation Form
- 12 Preparing to Expatriate
- 13 Offshore Compliance
Exit Tax For Legal Permanent Residents
For many, Expatriation U.S. Exit Tax for Long-Term U.S Residents (Green Card-Holders) is not only a surprise — but potentially a devastatingly costly endeavor.
For many Legal Permanent Residents (aka Green Card Holders) who relocated to the United States for a significant period of time only to relinquish their green card and return to living outside of the United States, they are coming to a harsh reality – they owe the United States tax money under the IRS Expatriation Laws.
Moreover depending on the total value of their assets and/or their annual income, their tax bill may be pretty steep.
Technically, the term is called “Expatriation Tax” and it is generally reserved for U.S. Citizens and Long-Term Green Card Holders, who meet the definition of a “Covered Expatriate.”
While most people believe that this “Tax” (Read: Penalty) only relates to U.S. citizens who renounce their citizenship, that assumption is incorrect. Rather, once a Legal Permanent Resident is considered to be a Long-Term Permanent Resident, they become subject to the expatriate tax — just as if they were U.S. Citizens.
What is the purpose of the Expatriation Tax?
The main purpose behind Expatriation Tax is to ensure individuals who have accumulated significant amount of assets or money while they were residents in the United States and/or were considered high income earners cannot simply relinquish their green card and leave the United States — in order to avoid all taxation.
Exit Tax Avoidance Example
Ernesto moved from Portugal to the United States nearly 15 years ago. While he resided in the United States, Ernesto obtained his Master’s Degree, as well as earned a nice six-figure salary. Moreover, Ernesto invested in various stocks and securities, which have grown significantly over the 15-year period. To date, Ernesto’s value is upwards of $5 million.
If Ernesto simply packed up, moved overseas, and relinquished his green card, he would no longer be subject to US tax; (technicalities permitting) he would be considered a foreign person.
Why is this important? Because as a foreign person who is selling U.S. capital gains, he may be able to avoid all US tax. That is because depending on various tax treaties and general passive investment tax laws, the United States does not tax all forms of US income when it is held by a foreign person — and generally, U.S. Capital Gains are exempt from Tax.
Sure, while Ernesto was a Legal Permanent Resident/Green-Card Holder he was considered a US person and subject to tax on U.S . Capital Gains. But simply owning U.S. stocks and securities (which are increasing in value but have never been sold) does not amount to a taxable event; in other words there is no tax realized during the growth of the investment.
The IRS wants to prevent people from coming to the United States, earning significant amounts of money, and then when it’s time to pay U.S. tax on those earnings to relinquish their green card-and not be subject to tax.
Is the Expatriation Tax fair?
There are two schools of thought: The first school of thought is that the gain was realized while Ernesto was residing in the United States. Depending on which country he was from, there may be some foreign tax liability to his country of residence during the time the stocks are growing, but since Ernesto was residing in United States, he did not have to pay any U.S. tax on the gains until the stock is sold. Thus, it is not “fair” that he can leave without paying any tax.
Conversely, simply because Ernesto came to the United States and was a successful and astute investor, does not mean he should still be subject to the IRS tax once he relinquishes his green card.
Why? Because he no longer resides in the United States and is no longer US person enjoying the benefits of being a “U.S. Person.” Thus, since he is not deriving those benefits at the time he sells the stock, is it really fair for him to be taxed on gain he never even realized (remember, under the Expatriate Tax he is not really selling the stock) solely because he is relinquishing his green card?
The IRS does not Care if it is Fair…
If you have ever dealt with the Internal Revenue Service, then you are aware that simply being fair is not a part of the US Tax Plan and these tax laws can get as creative as a Dr. Seuss tale.
Therefore, if Ernesto is considered to be a covered expatriate, then he is going to have to pay a significant tax based on the value of the stock’s gain on the day before the expatriates.
Are you a Long-Term Resident?
The most important first step a former (or soon to be former) Green-Card Holder must determine is whether they are actually a long-term resident . If not, then the Expatriate rules do not apply (unless of course he or she was a U.S. Citizen).
A long-term resident is a green card holder who has been in the United States for at least eight (8) of the last 15 years. The rule does not mean the resident has to be in the United States for a straight eight years. Rather, if the Resident resides in the United States intermittently for at least eight (8) years over the last 15 years than unless other exemptions apply (foreign treaties, students, dual citizens, minors) he or she will most likely be considered a long-term permanent resident.
What does it mean to be a “Covered Expatriate”
The next important step in determining whether a person is subject to the expatriation tax determined whether they are a covered expatriate. Not all Long-Term Legal Permanent Residents are considered to be covered expatriates. Rather, it will depend largely on the amount of income a person earned and/or the value of their assets.
The IRS publishes certain minimal annual income requirements which the Long-Term Resident must meet in order to qualify as a covered expatriate. Since it is 2016, we will focus on the portion that involves expatriation on or after June 17, 2008 (the most recent law), as follows:
Am I a Covered Expatriate?
The expatriation tax provisions under Internal Revenue Code (IRC) sections 877 and 877A apply to U.S. citizens who have renounced their citizenship and long-term residents (as defined in IRC 877(e)) who have ended their U.S. resident status for federal tax purposes. Different rules apply according to the date upon which you expatriated.
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 ($151,000 for 2012, $155,000 for 2013, $157,000 for 2014, and $160,000 for 2015).
– 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.
How does Expatriation Work?
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.
The amount that would otherwise be includible in gross income by reason of the deemed sale rule is reduced (but not to below zero) by $600,000, which amount is to be adjusted for inflation for calendar years after 2008 (the “exclusion amount”). For calendar year 2014, the exclusion amount is $680,000. For other years, refer to the Instructions for Form 8854.
The amount of any gain or loss subsequently realized (i.e., pursuant to the disposition of the property) will be adjusted for gain and loss taken into account under the IRC 877A mark-to-market regime, without regard to the exclusion amount. A taxpayer may elect to defer payment of tax attributable to property deemed sold.
For more detailed information regarding the IRC 877A mark-to-market regime, refer to Notice 2009-85.
The IRS generally likes to penalize individuals do not meet tax compliance requirements. More over, the iris really likes to penalize individuals especially when the noncompliance involves international and foreign, offshore income and offshore tax compliance issues.
As provided by the IRS:
Significant penalty imposed for not filing Expatriation Form
The Internal Revenue Service reminds practitioners that anyone who has expatriated or terminated his U.S. residency status must file Form 8854, Initial and Annual Expatriation Information Statement, and its Instructions. Form 8854 must also be filed to comply with the annual information reporting requirements of IRC 6039G, if the person is subject to the alternative expatriation tax under IRC 877 or IRC 877A. A $10,000 penalty may be imposed for failure to file Form 8854 when required.
IRS is sending notices to expatriates who have not complied with the Form 8854 requirements, including the imposition of the $10,000 penalty where appropriate.
The Instructions for Form 8854 provide details about the filing requirements, related definitions and line-by-line instructions for completing the form. Failure to file or not including all the information required by the form or including incorrect information could lead to a penalty.
Preparing to Expatriate
If you are preparing to relinquish you green card, it is very important to speak with an experienced international tax lawyer to assess and evaluate your financial situation and determine whether you are a Long-Term Legal Permanent Resident, and if you are – whether or not you meet the threshold requirements for being a covered expatriate.
There may be some alternatives, exceptions and exclusions involving getting into compliance with respect to expatriation.
In addition to the expatriation, there is an equally important issue involving whether or not you have been in compliance with offshore and foreign accounts, income and assets at the time your expatriate.
Why? Because if you are not in compliance (FBAR, 8938, Schedule B, 5471, 8621, 3520, 3520-A, etc.), but you wrongfully affirm that you have properly filed all of the proper foreign tax documents in accordance with form 8854, you may be opening yourself up to a whole host of new penalties and fines which you never contemplated prior.
Call now; we can help.
The following is a brief summary of general Offshore Reporting requirements.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)