Renouncing US Citizenship and the Dual Citizen Exception to the Exit Tax
According to Treasury Department numbers, 2016 broke the record for annual U.S. citizenship renunciations with a grand total of 5,411 renunciations. As we’ve noted previously, possible reasons for the increase in renunciations include the global strengthening and influence of the Foreign Account Tax Compliance Act (“FATCA”) and President Trump’s election victory (the “Trump bump”).
One of the major tax consequences of renouncing citizenship is the potential application of the “exit tax” if you are a so-called “covered expatriate.” Recognizing that the harsh consequences of the exit tax may not be appropriate in the case of expats who have limited ties to the United States, Congress enacted an exception to the exit tax in the case of certain dual citizens. For dual citizens considering renunciation, falling under this exception could be hugely beneficial from a tax perspective.
Who is a “Covered Expatriate”?
In general, 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 ($162,000 for 2017).
- Your net worth is $2 million or more on the date of your expatriation.
- You fail to certify on Form 8854 that you have complied with all U.S. federal tax filings and obligations for the 5 years preceding the date of your expatriation.
The Exit Tax
The exit tax applies both to covered expatriates who relinquish citizenship and to green card holders who relinquish their green cards (including by taking treaty positions) if they held their green card for a period of 8 years during the last 15 years.
The exit tax is a tax on the built-in appreciation in all of the expatriate’s property held at the time of expatriation (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.
In addition to the exit tax, it should be noted that Section 2801 of the U.S. Internal Revenue Code imposes a tax on US citizens or residents who receive gifts or bequests from covered expatriates. 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 (the rate is 40% in 2017).
Exception for Dual Citizens
Under the dual citizen exception, a renouncer who fails either of the first two covered expatriate conditions above (the net income or net worth tests) will still be exempt from the exit tax if the following conditions are met:
- You became a U.S. citizen at birth;
- You also became a citizen of another country at birth;
- On the expatriation date, you continue to be a citizen of that other country;
- On the expatriation date, you continue to taxed as a resident of that other country; and
- You have been a resident of the United States for not more than 10 taxable years during the 15-taxable year period ending with the expatriation year.
Exemption from the exit tax can mean significant tax savings upon renunciation. It’s important to note, though, that qualifying for the dual citizen exception does not relieve renouncers from the third condition mentioned above – namely certifying on Form 8854 that you have complied with all U.S. federal tax filings and obligations for the 5 years preceding the date of your expatriation.
For expats seeking renunciation, this third condition may require catching up on late or missed filings. In this regard, a number of options are available for delinquent filers – including the highly advantageous Streamlined procedures for taxpayers whose past reporting failures were due to non-willful conduct.
If you are considering renunciation and need to catch up with the IRS on your expat tax returns and FBARs, our experts at Expat Tax Professionals are available to discuss your options and craft a solution that best meets your needs and circumstances.
By Ephraim Moss, Esq. & Joshua Ashman, CPA