According to the latest Treasury Department figures, the number of people who expatriated from the U.S. jumped nearly 45% during the fourth quarter of 2023 compared with the previous quarter.
These high numbers don’t include green card holders who have abandoned their legal permanent resident status - a move that, from a tax perspective, comes with many of the same challenges as renunciation.
What’s the motivation behind this trend? Some believe that the nuisance of U.S. tax compliance is the main culprit. FATCA has given the IRS a longer reach in recent years to pursue U.S. citizens living abroad who have not kept up with their U.S. filing obligations. Renunciation is certainly one solution in this regard.
In this blog, we review the tax and reporting implications of renouncing one’s citizenship and abandoning one’s green card. We then describe how our firm can help you navigate the process. We include a case study involving real facts, so that you can fully understand our approach and the services we offer.
Defining a Covered Expatriation
The main tax tax and reporting implications associated with renunciation stem from the so-called "exit tax" rules. The exit tax potentially applies to so-called “covered expatriates,” a term that is specifically defined under the Internal Revenue Code (Sections 877 and 877A).
Under the Code, Under IRC Section 877A(g)(3), an “expatriate” is defined as either:
(1) a U.S. citizen who renounces (or otherwise loses) his or her U.S. citizenship, or
(2) a “long-term resident” who (i) abandons (or otherwise has revoked) his or her green card, or (ii) takes a treaty position that he is no longer a U.S. tax resident and notifies the IRS of the commencement of such treatment (i.e., by filing Forms 8854 and 8833 to claim the treaty position).
A “long-term resident” is defined in IRC Section 877 to mean an individual (other than a citizen of the United States) who is a lawful permanent resident of the United States (i.e., a green card holder) in at least 8 taxable years during the period of 15 taxable years ending with the taxable year during which the expatriation occurs (the “8-ouf-of-15-year rule”).
The Code specifies that for purposes of the 8-out-of-15-year rule, a treaty residency exception applies, as follows: “an individual shall not be treated as a lawful permanent resident for any taxable year if such individual is treated as a resident of a foreign country for the taxable year under the provisions of a tax treaty between the United States and the foreign country and does not waive the benefits of such treaty applicable to residents of the foreign country.”
“Covered expatriates” are expatriates for which any of the below is true:
- Your average annual net income tax for the 5 years ending before the date of expatriation is more than a specified amount that is adjusted for inflation ($190,000 in 2023).
- Your net worth is $2 million or more on the date of your expatriation.
- You fail to certify to the IRS that you have complied with all U.S. federal tax obligations for the 5 years preceding the date of your expatriation.
Exceptions to the exit tax may apply in the case of dual citizens from birth and certain minors who expatriate before the age of 18½.
Each individual's particular circumstances should be analyzed in order to determine if an exception properly applies.
The Exit Tax
An individual who fails any of the above covered-expatriate criteria is subject to the exit tax on the net unrealized gain in the individual’s property (such as a house) as if the property had been sold for its fair market value on the day before the expatriation date. Net capital gains are currently taxed at the rate of up to 23.8% (20% maximum capital gains tax plus the 3.8% net investment income tax).
It is important to note that gain is recognized only to the extent that the deemed gain exceeds in aggregate $600,000, as indexed for inflation. For 2023, the indexed amount is $821,000. Also, the basis of each item of property is adjusted to its fair market value as of the day preceding the expatriation date, for purposes of determining any gain or loss that may be realized subsequently from the actual disposition of the property.
For the majority who pass the first two covered-expatriate criteria, avoiding the exit tax comes down to proving a history of tax compliance.
A delinquent taxpayer should consider entering into an IRS tax amnesty program to clean up the past and keep IRS penalties at bay, prior to renouncing.
The Streamlined Filing Compliance Procedures are available for U.S. expats whose failure to file was due to non-willful conduct. Under this popular tax amnesty program, the taxpayer is required to file the prior 3 years of tax returns, including required information returns, and 6 years of FBARs. A delinquent U.S. expat who complies with these procedures will have to pay previously unpaid taxes with interest, but will not be subject to any penalties.
Alternative Implications for Pensions and Similar Items
If you have a retirement savings account (i.e., a pension), a different set of tax rules apply upon renunciation if you’re classified as a covered expatriate. These rules can be particularly harsh when they result in the double taxation of your savings, which you have worked so many years to accumulate in anticipation of your eventual retirement.
Importantly, deferred compensation items such as pensions are exempted from any adverse consequences upon renunciation to the extent attributable to services performed outside the U.S. while the renouncer was not a citizen or resident of the United States.
In this regard, it’s not uncommon for non-U.S. citizens moving to the United States to “freeze” their rights in their foreign pension plan that covered them prior to the move. In this case, this exception may provide substantial relief from any withholding obligations or substantive tax liabilities.
The ETP Approach
At Expat Tax Professionals, we recognize that the big decisions require expert consideration. That is why we focus on being creative, practical and efficient. Our personalized service simplifies the complex and offers creative solutions to ostensibly difficult situations.
In this regard, we take a two-pronged approach to expatriation servicing: First, our advisory services ensure that a renouncer or green card abandoner can implement their decisions in the most tax-effective way available under the U.S. domestic tax and treaty rules.
Second, our compliance services ensure that the all reporting and disclosure requirements are met, both in the case of up-to-date filers and those who need an amnesty program to clean up the past.
Client Case Study
Background: Clients are UK citizens who moved to the U.S. in 2012 (and obtained green cards in 2015), and then moved back to the UK in June of 2022.
Their combined assets exceed $4m, and the husband has a number of (U.S. and foreign) pensions and a significantly appreciated UK home. They want to fix past compliance mistakes and abandon their green cards.
Services and Solutions: Our firm recognized the client’s need for both advisory and compliance tax services.
On the advisory side, we assisted with:
- Exit Tax Research – we advised on the nuances and implications of the long-term resident status rules for green card holders, including the utilization of the US-UK treaty to determine residency status.
- Exit Tax Planning – we provided concrete and actionable solutions for eliminating adverse exit tax implications, including inter-spouse gifting strategies. This saved the client around $400K in taxes (!) by avoiding the deemed distribution of the husband’s pensions. Our advice was documented in a detailed tax memorandum, a hallmark of our advisory deliverables.
- Global coordination – we coordinated with the client’s UK advisors to ensure a cohesive global approach that takes into account both U.S. and UK tax implications.
On the compliance side, we assisted with:
- Review of Past Returns – we reviewed the client’s previous tax returns and other submissions to see if amendments are needed.
- Cleaning up the Past – we prepared a Streamlined Domestic Offshore Procedures Amnesty Program submission to correct past returns and ensure full compliance in past years.
- Expatriation Compliance – we prepared the client’s tax return for the current year of expatriation, including preparing the Form 8854, the required form for expatriations.
If you are considering renouncing your U.S. citizenship or abandoning your green card, it is important that you understand the tax consequences before turning in your passport or green card for good.
Our experts at Expat Tax Professionals can help you understand the options and strategies available to you based on your particular circumstances. Our comprehensive approach to an effective renunciation can ensure that you are compliant and tax-efficient.
Contact us for more information.