Exit Tax & Expatriation Planning
Exit Tax Planning: The Exit Tax Planning rules in the United States are complex. U.S. Citizens & Green Card Holders may become subject to Exit tax when relinquishing their U.S. status. The IRS requires covered expatriates to prepare an exit tax calculation, and certify prior years’ foreign income and accounts compliance.
In recent years, the IRS has taken an aggressive position in enforcing offshore account, assets & investment reporting. If a person has not been compliant, they may qualify for FBAR Amnesty or FATCA Amnesty — collectively referred to as voluntary disclosure.
When a person is considering leaving the U.S. permanently, there may be exit tax planning issues to consider.
As provided by the IRS:
“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.”
Planning for Expatriation (and Exit Tax)
The Basics of Expatriation Tax Planning: IRS tax rules for expatriation from the United States requires a complicated tax analysis to determine if the expatriate must pay U.S. Tax.
Exit Tax and Expatriation involve certain key issues. These typically include:
- Renouncing U.S. Citizenship
- Relinquishing a Green Card
- Exit Tax
- Form 8854
- Covered Expatriates
Common Questions involving Exit Tax Planning
What is U.S. Exit Tax?
U.S. Exit Tax is the IRS and U.S. Government’s way of making individuals who are considered U.S. Citizens or Long-Term Residents to pay a tax (depending on certain factors) to the U.S. Government upon “Exiting” or “Expatriating” from the U.S.
Is there a U.S. Exit Tax for Green Card Holders?
Yes. The Exit may apply to U.S. Citizens and Green Card Holders aka Legal Permanent Residents, if they qualify as an LTR (Long-Term Resident)
How much is the Exit Tax?
The Exit Tax varies based on many different factors.
Depending on the type and source of income, it may be immediately taxable vs. taxed at a future date, once the income becomes distributed and taxable.
How much is the Expatriation Tax?
Expatriation Tax and Exit Tax are the same concepts — there are not two different types of taxes for relinquishing a green card or renouncing citizenship.
How is Exit Tax Calculated?
Essentially, the first step is to determine if you qualify as U.S. Citizen or Legal Permanent Resident. Next is to determine if an exception applies.
Then, if the person is a Long-Term Resident or Citizen with no exception, the person must determine if they meet one of the three threshold requirements to be considered a “Covered Expatriate.” Then, the person calculates the exit tax based on each specific asset.
Do I have to Pay Taxes if I Renounce my Citizenship?
That depends on whether the person owes an Exit Tax, or otherwise continues to earn income that would be considered U.S. Sourced, or otherwise subject to U.S. Tax.
Do I have to Pay Taxes if I Relinquish my Green Card?
That also depends on if the Legal Permanent Resident owes an Exit Tax, or otherwise continues to earn income that would be considered U.S. Sourced, or otherwise subject to U.S. Tax.
The following are the typical categories of individuals we work with for exit tax planning.
For some people, they may have citizenship in a foreign country but are considered Legal Permanent Residents (aka Green Card Holders) in the United States and were never made aware of the true tax consequences of being considered a US person (especially worldwide taxation).
Many clients we work with were under the misimpression (understandably so) that citizen-based taxation involves U.S. citizens.
And, since Legal Permanent Residents/Green Card Holders are not citizens of the United States, they would not be subject to worldwide income and offshore reporting.
Another group of individuals who are being unfairly burdened by FATCA and other offshore reporting rules are Accidental Americans.
There has been a surge in the number of Accidental Americans that we have been working due to the fact that many of them had no idea that they were considered Americans.
The typical example is an individual whose parents were US citizens and they may have been born in the United States or outside of the United States to U.S. Citizen parents — and literally never thought of themselves as US citizens.
Why would they?
They reside outside of the United States and in many situations have literally never stepped foot in the US.
As a result, it is dumbfounding if not mind-numbing to believe that the US requires these individuals to still report and pay tax to the United States.
U.S. Citizens or Green Card Holder Turned “Expat”
A final category of individuals we work with, are US citizens who have simply moved outside of the United States and have literally no intention of ever returning.
As a result, the idea of paying continual US tax in a situation in which they may live in a low tax jurisdiction and the receiving income which is considered tax-free under the laws of their current country just makes no sense.
As a result, these individuals want to renounce their US citizenship.
Why Does the IRS Care?
Because the IRS believes (incorrectly), that proper tax avoidance is the same as illegal tax avoidance (e.g. attempting to avoid long-term status in the United States in order to avoid paying tax)
Here’s a typical example: David a Permanent Resident who came to the United States in 2010. While in the United States David earned millions upon millions of dollars and uses that money to purchase stocks and investments offshore. David is smarter than the rest of us and was able to successfully grow his investments into the solid eight figures.
David wants to expatriate from the U.S. for multiple reason, including paying any “exit tax.”
When David leaves the United States, if he was considered to be a long-term resident, he would be subject to certain taxes (aka exit taxes) that he would otherwise not be subject to if he was not considered a long-term resident.
As a result, David leaves the United States after 7 years, and gives up his green card prior to having to pay any exit tax.
Key Exit Tax Planning Tips
The following are a few key tips to keep in mind:
Don’t Become a Legal Permanent Resident or Citizen
In order to even be subject to the IRS covered expatriate and exit tax rules, a person must be a U.S citizen or long-term legal permanent resident.
Therefore, the easiest way to avoid the long-term resident exit tax trap it is to simply avoid becoming a legal permanent resident.
This may not always be conducive for work purposes, but it is something to keep in mind — based on the taxpayers’ age individual persons specific goals, facts and circumstances.
Be Cognizant of the “8-Year Rule”
When a person is a legal permanent resident, they do not become a long-term resident until they have been a legal permanent resident for at least eight of the last 15 years.
Therefore, try to time the status accordingly to avoid the 8-year trap.
*It does not have to be eight full years.
**The LPR does not need to have to reside in the U.S.
Don’t Just Let Your Permanent Resident Status Lapse
When it comes time to abandon the legal permanent resident status, it must be done voluntarily. One easy way is worth USCIS Form I-407.
Just because a green card expires doesn’t mean a person has voluntarily abandoned their legal permanent resident status for tax purposes.
The green card is used to reflect LPR status.
Reduce Net Worth
If it is possible for the taxpayer to reduce their net worth to below $2 million, they will not meet the first net value test.
Gifting Money Before Expatriation
One way to reduce net worth is by gifting accounts, money and assets. This can significantly reduce net income tax liability. The key important issue with gifts is to determine whether the taxpayer and spouse are U.S citizens or not.
There is (usually) an unlimited exception when the gift is transferred to the U.S citizen.
Of course, of the US citizen spouse is then going to give up his or her status down the line as well, it could be just kicking the can down the road – which is why exit tax planning is important
When a person has a foreign retirement plan, that is generally going to be considered an ineligible retirement plan, resulting in a deemed distribution for the value on the day before expatriation.
It is important to assess whether or not there is a way for the U.S. person to transfer or gift that money to another person, and therefore avoid the exit tax deemed distribution rules.
As you can imagine, retirement plans are designed to defer income and therefore there could be some serious hurdles in foreign retirement planning.
Possibly, if the individual was able to move the investment accounts from the retirement into a savings account aka cash, without a deemed distribution in the foreign country, then there might be some wiggle room to avoid the deemed distribution, and avoid any unrealized tax, since the money is now in a savings account — but this is can be risky, and the IRS may pullback the money.
Individuals should speak with an attorney form the specific foreign country where the retirement is located – before they expatriate.
Reduce Net Income Tax Liability
Likewise, if a person has a significant tax burden, they may consider ways to reduce their net income tax liability to reduce the 5-year average.
One way — if applicable — is to stop filing married filing jointly, especially when it is the non-covered expatriate spouse with the significant tax liability.
Avoid the 5-Year Trap
Be sure to be in tax compliance for the five years prior to expatriation. If you have been out of compliance and prior years you may consider offshore disclosure to get into compliance and anticipation of expatriation.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.