The recent upsurge in US citizenship renunciations has a number of possible causes. In some cases, the reasons may be political or personal. In other cases, renouncers no longer want to deal with complicated U.S. tax paperwork. In still other cases, renouncing citizenship can be an important planning tool for U.S. expats who are trying to reduce the adverse U.S. tax consequences associated with activities abroad.
While renouncing comes with a number of important non-tax considerations, the role that the IRS plays in the decision to renounce should not be underestimated.
At the heart of the IRS reporting associated with renunciation lies the Form 8854 (“Initial and Annual Expatriation Statement”). The role that the Form 8854 plays in renouncing US citizenship is often misunderstood. In this blog, we carefully analyze the Form 8854, both in the context of renouncing one’s citizenship and in abandoning one’s green card, in order to clarify the role of compliance when exiting the US tax net.
WHAT IT MEANS TO EXPATRIATE
In contrast to immigration law which generally focuses on concepts such as citizenship and residency, the main tax concept at play when leaving your status as a US person is “expatriation.” The Internal Revenue Code defines expatriation as either relinquishing your US citizenship or abandoning your green card if you held it for a period of 8 years or more during the previous 15 years (rendering you a so-called “long-term resident”). There are exceptions that can apply in the both cases.
Importantly, the Internal Revenue Code applies a so-called “exit tax” upon the renunciation of citizenship or the termination of long-term residency by a so-called “covered expatriate.” It also applies a so-called “Section 2801 tax” to gifts and bequests from a covered expatriate.
THE TAX CONSEQUENCES OF EXPATRIATION
The exit tax is a tax on the built-in appreciation in the expatriate’s property (such as a house), as if the property had been sold for its fair market value on the day before expatriation. The current maximum capital gains rate is 23.8%, which includes the 20% capital gains tax and 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 2019, the indexed exemption amount is $725,000.
Section 2801 of the Internal Revenue Code imposes a tax on US citizens or residents who receive gifts or bequests from covered expatriates who have relinquished their U.S. citizenship. A U.S. recipient of a covered gift or bequest is subject to a tax equal to the value of the covered gift or bequest multiplied by the highest estate tax rate in effect on the date of receipt (40% in 2019).
WHERE DOES THE FORM 8854 FIT IN?
With the above background, we can now understand the important role that the Form 8854 plays in this story. Remember that in order for the exit tax and Section 2801 tax to potentially apply, an expatriate must have the status of a “covered expatriate.”
In this regard, you are considered a “covered expatriate” if any of the following applies:
- 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 ($168,000 for 2019).
- Your net worth is $2 million or more on the date of your expatriation; or
- 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.
Meaning, even if you pass the first two tests upon expatriating, the exit tax and Section 2801 tax can apply to you if the Form 8854 is not filed with a final tax return following your expatriation. This makes the Form 8854 a critical reporting requirement in order to avoid the harsh potential tax consequences associated with renouncing or abandoning one’s green card as a long-term resident.
FORM 8854 AND CERTIFYING PAST COMPLIANCE
Importantly, the Form 8854 requires that you certify that you have complied with all U.S. federal tax obligations for the 5 years preceding the date of your expatriation. For those who have not been filing, options for coming back into compliance should be explored.
In this regard, the IRS recently announced the opening of a new amnesty program aimed specifically at tax-delinquent US citizens who relinquished, or intend to relinquish, their U.S. citizenship, and who wish to come into tax compliance and avoid being subject to the U.S. exit tax among other negative ramifications associated with non-compliance - Relief Procedures for Certain Former Citizens.
This program and the Streamlined Procedures are now two great options for coming clean with the IRS, depending on your situation. Several other amnesty options are available as well. Each option has its advantages and disadvantages, and choosing the best way forward requires a careful analysis of your particular facts and circumstances.
Our experts at Expat Tax Professionals are available to help discuss your options and guide you through each step of the disclosure process.