Which Assets Are Subject to Tax If I Renounce Us Citizenship?

Which Assets Are Subject to Tax If I Renounce Us Citizenship?

Which Assets Are Subject to Exit Tax?

When a U.S. Citizen (or Long-Term Lawful Permanent Resident) wants to give up their U.S. person status (aka renounce their U.S. Citizenship), the formal process is referred to as Expatriation. Over the past 10 years, there has been a recent uptick in renunciation cases. For some taxpayers, the main reason they are renouncing is that they are planning to leave the United States and citizenship is no longer necessary – and the tax implications are secondary. For other taxpayers, the sole reason they want to renounce is to minimize taxes – although technically the US government does not have to approve a renunciation if it is based on tax-related reasons only. A very common question Taxpayers have when they renounce is about which assets are (potentially) subject to the exit tax. Let’s take a brief look:

Covered Expatriate and Exit Tax

First, not everyone is subject to an exit tax at the time they renounce their US citizenship. A person must be a ‘covered expatriate’ to potentially become subject to an exit tax — since not all covered expatriates are subject to the exit tax. Likewise, it is not a wealth tax per se so a very wealthy taxpayer who holds all of their assets in cash may have no exit tax – whereas a less wealthy covered expatriate with a low adjusted basis and high fair market value of stocks and shares, for example, may have a significant exit tax.

Domestic and Foreign Assets

One of the most important aspects of expatriation is the fact that even though the person is only expatriating from the United States, they are subject to an exit tax on their worldwide assets. Depending on where the assets are located and the specific category of assets (along with potential step-up value assessments) may impact the application of the exit, but the general rule is that all assets are included for exit tax purposes.

Stock, Securities, and Real Estate (Mark-to-market) 

The most common type of exit tax a person may have to pay with respect to renouncing US citizenship is based on the mark-to-market growth for assets including stock, securities, and various other types of assets such as real estate. Essentially, a person will look at the value of the cost/adjusted basis along with the Fair Market Value on the day before they renounce — and then determine if there is any gain above the exclusion amount

Pension (Eligible vs Ineligible)

Pensions are subject to exit tax but not all pension plans qualify. If a person has an ineligible pension, which oftentimes would be something such as a foreign pension plan — then subject to the step-rules — it is deemed distributed on the day before they expatriate. When someone has an eligible deferred compensation plan such as a 401(k) it is typically not taxed at exit — but later when distributions are made, the taxpayer will pay tax at the time and they have to give up the right to make a treaty election to reduce withholding.

Tax Deferred Specified Accounts (Traditional IRA)

When someone has a tax-deferred specified accounts such as a traditional IRA, they generally lose the tax benefits at the time they renounce. At the time of exiting the U.S., they are required to gross up the value of the IRA for example — and other similar types of tax deferred specified accounts – and include it in their income. With a Roth IRA, presuming that the taxpayer has met all the prerequisites such as age and time in the fund, it will not be taxable at exit (although some exceptions, exclusions, and limitations to the tax deferral rules may apply).

Trust Ownership

When a person has ownership of a trust, their ownership percentage may become subject to the exit tax. Trusts become very complicated, depending on whether it is a US trust or a foreign trust — and whether it is a grantor trust or non-grantor trust. Taxpayers should be careful in settling any trusts before exiting, because while they think they may be limiting their tax liability, it can very well open up a Pandora’s box unless it is done properly.

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