Exit Tax for US Expatriates – Second passport and citizenship program

If you have taken the far-reaching and irrevocable decision of giving up your US citizenship to permanently disconnect from your US tax obligation, you still have to settle your exit with the IRS. On June 17, 2008 the new law came into force that made it relatively easier comparing to the previously existing regulations. Though now, if you are wealthy enough, giving up your US citizenship proves to be a rather expensive step.

Covered Expatriates and Exit Tax Threshold

The law applies to US citizens who expatriate, as well as long-term US permanent residents who give up their green cards, which they have held for 8 of the last 15 years. Both categories are subject to immediate “exit tax” on unrealized gains on all their assets in the US and worldwide, including grantor trusts, as well as on any future gifts or bequests to US citizens and residents, if any.

You qualify for the covered expatriate and the related exit tax, if you meet any of the following criteria:

• you have a net worth of US$ 2 million or more;
• you have an average net U.S. income tax liability of greater than US$ 139,000 for the five year period prior to expatriation; or
• you fail to certify that you have complied with all U.S. federal tax obligations for the preceding five years.

The exceptions are dual nationals from birth, who have not lived in the US for more than 10 years from the last 15, and persons younger than 18½ who have not lived in the US for more than 10 years.

Mark-to-market Tax on Unrealized Gains

The exit tax is being applied to the net unrealized gains on the covered expatriate assets estimated on the “mark-to-market” basis, as if the assets were sold on their fair market value on the day preceding the expatriation. The first US$ 600,000 gains are exempt from the tax. Any gain over US$ 600,000 is subject to US income tax.

The tax payment is due within 90 days after giving up your US citizenship. Expatriation is considered effective for tax purposes even if you fail to file the Expatriation Information Statement (form 8854).

The exceptions from the main rule are certain deferred compensation items, specified tax deferred accounts, and non-grantor trusts.

Specified tax deferred account is subject to immediate inclusion in the expatriate’s income subject to exit tax. This provision covers among all certain individual retirement plans, tuition programs, Coverdell education savings accounts, and health savings account, Archer MSA. No further tax, such as early distribution tax, is to be applied to these items thereafter.

30% Withholding Tax

Deferred compensation items, depending on their nature, are either subject to 30% withholding tax at the moment of payment, or to be included in the personal income of the expatriate subject to exit tax. Those items, that are subject to 30% withholding tax by being a distribution to covered expatriates, are also most likely to be taxed again at the 30% rate as payments to non-resident aliens. Such treatment may cut certain pension plans and retirement accounts by up to 51% net tax.

Withholding tax rate is not subject to reduction under any of the existing tax treaties between the US and other countries.

Distributions of non-grantor trusts are treated the same way with certain exceptions.

Future Gifts and Bequests

If being a covered expatriate you make a gift or bequest to a US citizen or resident in the amount exceeding US$ 12,000 in any calendar year, the recipient, including in case it is a US trust, is to withhold the tax at the highest marginal estate or gift tax rate existing on the moment of the gift or bequest, with no regular allowances for the same taxes granted to US persons. Though, any tax already paid to a foreign country in regards with the covered gift or bequest is allowed for credit in the US.

The covered gift or bequest is exempted from the tax, if the recipient is a US spouse or a qualified charity.

This provision is effective for your lifetime.

Furthermore, if you were not a covered expatriate at the moment of exit, but you qualify as such following the same criteria at the moment of making gift or bequest, the latter fall into the category of covered.

Procedure to Relinquish the US Citizenship or Residence

Basically, you need to undertake the following:

1. Get a second citizenship in another country.
2. Leave the US.
3. Appear before the US Consul in that country to renounce your US citizenship.
4. File the form 8854, Expatriation Information Statement.
5. Pay the due exit tax.

As a covered expatriate, you will be able to visit and even stay for certain time in the United States, and the mere fact of being an expatriate does not make you a US tax resident. You still can become taxable in the US under the normal US tax rules.

Best Time to Exit

Interestingly, but entry into force of the new rules concurred with development of the global financial crisis. The real property and other assets values are really depressed right now. The lower is the fair market price, the smaller unrealized gains it’s bringing, the easier it is to fit into the US$ 600,000 threshold.

If you have thought it well, you better do it now.