Renouncing US citizenship and the exit tax
There are many reasons why someone would decide to renounce their US citizenship: family reasons, a desire to commit to citizenship in one’s country of origin, disagreement with the US government, etcetera. Some people have reasons that may have to do with the US tax system: US citizens must file and pay taxes on all their income, no matter what country they earned it in. And now there is another reason – the Foreign Account Tax Compliance Act, or FATCA. FATCA, designed to combat tax evasion, requires foreign financial institutions (FFIs) to search their customer account records for US indicia, or indication of a connection, to the US and then report those accounts to the IRS. This can result in a significantly increased tax liability for US citizens who had not declared those accounts on their US tax returns.
The only way for a US citizen or permanent resident to be relieved of the obligation to file taxes and informational returns on all their income to the IRS is to renounce their citizenship.
However, the IRS has one last opportunity to tax high-income, high-asset citizens and residents as they become US expatriates. It is called the “exit tax” or “expatriate tax.“
Those who must pay the exit tax if at least one of the following statements applies:
— Your average annual net income tax liability for the 5 years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation ($160,000 for 2015, $161,000 for 2016, $162,000 for 2017 and $165,000 for 2018)
— Your net worth is $2 million or more on the date of your expatriation or termination of residency.
— 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 or termination of residency.
If at least one of these applies, the taxpayer is deemed a “covered expatriate.” The IRS determines the exit tax by adding up all the covered expatriate’s worldwide assets as if they were sold on the day before expatriation. The assets of married couples are considered as being owned by separate taxpayers. The tax amount is a percentage of these calculations determined by the IRS tax code.
There are, however, some useful strategies to manage exit tax liability, including shifting assets to take advantage of the gift exclusion and exclusion for capital gains. If you decide to renounce your US citizenship, it is worthwhile to consult and international tax attorney to come up with a strategy to minimize your tax liability.
Those renouncing their US citizenship who do not meet the financial standards of covered expatriates are not required to pay the exit tax.