Every four years, a tearful contingent of Americans announces its intention to forever leave the soon-to-be insufferable confines of the United States—should the presidential candidate of their intense disliking make it into the White House.
Here’s how to make their dream a reality…
—by J. Christoph Amberger, Esq.
Alas, that Trail of Crocodile Tears, lead by actors and entertainers, never quite seems to materialize: Election year or not, only about 500 stalwart souls annually have taken the plunge, handed in their dark-blue passports to the State Department, and renounced their U.S. citizenship. And reportedly, not one of them had children named “Apple”…
It wasn’t until 2013, after Congress passed the Foreign Accounts Tax Compliance Act (FATCA), that expatriations hit a record high of nearly 3,000. Considering that for each expatriate, 434 foreign-born individuals legally move to and 100 “anchor” babies are born each year to “undocumented migrants” inside the United States—at great risk and/or expense to the parents—even that 2013 record seems modest by comparison.
The reason for this disparity lies at least partly in the fact that Congress has made renouncing your citizenship about as enjoyable as getting a mouthful of root canals in the middle of a contested divorce, while deadlocked in child-support negotiations for college-age octuplets.
You are of course aware that the United States is rather unique in taxing its citizens’ worldwide income. Unsurprisingly, that makes taxation-related issues the most popular reason to renounce one’s U.S. citizenship. Until 2010, avoidance of U.S. income taxes may have made expatriation attractive mostly to those prosperous enough to incur tax bills high enough to make the cost of avoidance worthwhile. But the passing of FATCA imposed such a bureaucratic hassle on foreign banks, financial institutions and asset management companies that those institutions often found it cheaper to jettison their American clients, leaving citizen expats stranded in their country of residence without the necessary financial infrastructure to carry on normal life.
For those suddenly without the wherewithal to make a simple bank transfer in a country they’ve resided in for several decades, this seems like a good time to weigh the costs and benefits of renouncing their American citizenship.
There are two major steps you must take to formally surrender your U.S. citizenship. The first is handled by the U.S. State Department/Office of Homeland Security, through the U.S. embassies or consulates in your respective country of residence.
Very generally speaking, the United States will not permit you to surrender your U.S. citizenship unless you can prove citizenship in another country. After all, once you renounce the United States, we want you to be their problem! Depending on what country you want to become part of, that in itself may be a tall order: Many more countries are now actively courting émigrés (particularly those with money!) by handing out passports like ice cream cones. However, you still will find plenty where the good, old-fashioned jus sanguinis will permit you to spend your money freely year-round, albeit without any reciprocity in the citizenship department.
If you still have family in the States, or another reason to visit frequently, you may not encounter problems to obtain a visitor’s visa after you have expatriated. You may be subject to those parts of the U.S. Immigration Code that determine those priorities and procedures applicable to your new fellow-citizens, and which Congress left to the discretion of the State Department and its global staff: Try out the respective non-citizen lines at the immigration counters the next time you fly into the States to get a first taste! Should you determine later that you’d like to spend more than 60 days in the States at a time, you may be right back to square one in regard to your tax and FATCA troubles when you apply for the appropriate resident or temporary immigrant status.
By far the most involved (and expensive!) part of the expatriation racket is dissolving your relationship with the U.S. Treasury. After all, they may be the ones who’ll miss you most—or at least your annual tax check. The taxation aspects of your expatriation are ruled primarily by IRC § 877 and § 877A, which apply to all U.S. citizens who expatriate on or after June 17, 2008. To initiate this second step on your road abroad, you must file IRS Form 8854 with the Internal Revenues Service.
Until you file that form and notify the Department of State or the Department of Homeland Security of your expatriating act, your obligation to file U.S. tax returns and report your worldwide income remains unchanged. (Form 8854 must also be filed to comply with the annual information reporting requirements of IRC 6039G, if you’re subject to the alternative expatriation tax under IRC 877 or IRC 877A). A $10,000 penalty may be imposed for failure to file when required.
If your main motivation for expatriation was to avoid paying Federal income taxes or escape filing with the IRS, you’re in for a treat. Because the IRS wants to let you experience the whole nine yards of its VIP treatment, just for Auld Lang Syne.
The IRS applies a three-prong test to see if you’re an expatriate “covered” by § 877A. You care a covered expatriate if any one of the following statements applies to your circumstances:
* Your average annual net income tax 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 (i.e., $151,000 for 2012, $155,000 for 2013, $157,000 for 2014, and $160,000 for 2015).
* 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.
* You expatriated before 2015 and you: (a) Deferred the payment of tax, (b) Have an item of eligible deferred compensation, or (c) Have an interest in a non-grantor trust. (Some exceptions may apply to individuals with dual citizenship and those who relinquish citizenship prior to age 18½. Check for those in the Instructions for Form 8854 (2015), below.)
Mark to Market Tax
If you’re a covered expatriate in the year you expatriate, you’re also subject to income tax on the net unrealized gain in your property, just as if the property had been sold for its fair market value on the day before your expatriation date (hence, “mark-to-market tax”).
That’s like making you pay advance income or capital gains tax on something you haven’t sold yet and may never sell!
Gains from these “deemed” sales are taken into account without regard to other U.S. tax laws. Losses are taken into account to the extent otherwise allowed under U.S. tax laws. However, IRC § 1091 (relating to the disallowance of losses on wash sales of stock and securities) doesn’t apply. For 2015, the net gain that you otherwise must include in your income was reduced (but not below zero) by $690,000; the reduction amount for 2016 was not available as of this writing but probably will be around $700,000.
This mark-to-market tax applies to most types of property interests you held on the date of your expatriation. That may include bank accounts, real property, your coin collection, and any interest in property, regardless of whether it produces any income or gain. In addition, an interest in the right to use property will be treated as an interest in such property. (Have a life estate in a Swiss chalet? Yep, that’s probably taxable for expatriation purposes!)
There are exceptions for eligible deferred-compensation items and interests in non-grantor trusts (which are subject to withholding at source), ineligible deferred-compensation items (which are treated as receiving the present value of your accrued benefit as of the day before the expatriation date), and specified tax-deferred accounts (which are treated as receiving a distribution of your entire interest in the account on the day before your expatriation date).
Of course, to determine any gains, you have to know what basis to apply to the deemed sale. And if that reminds you of those long calculations on basis, step-ups, etc. that your tax adviser dazzled you with until your eyes glazed over in the context of charitable donations and capital gains taxes: Yes, it’s just as much fun.
Think it through
There’s neither enough time nor enough space to go into the more involved or individual aspects of the tax issues created by your expatriation in this article. Nor do the Maryland Rules of Professional Responsibility allow me to tell you that what I’ve told you so far constitutes “legal advice”.
Suffice it to say that this is an extremely complex area of the Federal immigration and the Federal tax codes that you really should not attempt to tackle by yourself. To avoid costly mistakes, enroll the assistance of an experienced tax and immigration attorney, ideally one with additional competencies as a CPA.
In addition, the “deemed sales” of your foreign assets to determine your Mark-to-Market tax will probably also require the assistance of local accountants and legal professionals who can assist with and certify valuations and local currency-to-dollar conversion issues.
In countries that have experienced currency reforms in the time you’ve been living and acquiring property there, you may require assistance certifying appropriate internal conversion rates (such as DM to Euro and Euro to dollar, etc.) to determine the basis of your initial purchase. Also, you will need a local tax attorney or adviser to consult with in regard to the tax effects of U.S. taxation in view of your annual filing in your new country of citizenship, to avoid dual taxation issues.
My own opinion? Glad you asked!
Keep in mind, expatriation under the immigration code had its roots in governmental sanctions: Historically, the government could withdraw citizenship from those it deemed unfit or unsuitable—such as immigrant mafiosi or concentration camp guards or, in an earlier age, imprudent American women marrying foreign nationals! It never was supposed to be fun or easy.
Having observed a number of American expats whose Europhilia drove them to abandon their U.S. citizenship for the presumably greener pastures of various EU member states, it’s been my impression that expatriation more often than not turns out to be a penny-wise proposition.
If taxation issues are your main motivator, rest assured that tax laws tend to change periodically, usually just about when you think you’ve figured it all out and shifted your finances to a jurisdiction that seemed more advantageous at the time.
The less assets you own, the cheaper and less “taxing” the process will be. Of course, so will be the benefits of expatriation. So even if the retention of your U.S. citizenship creates seemingly insurmountable problems for you, before you commit yourself to expatriation, get a good feeling for what you’re getting yourself into: It may be hard to get out of!
This information is provided as educational material only. It is not legal advice. It does not create an attorney-client relationship. Always seek independent legal counsel.
Some Light Reading: