Some U.S. citizens decide to relinquish their citizenship, move abroad and remove themselves from the U.S. tax net. Renouncing citizenship brings myriad legal, financial and tax implications affecting investments, tangible and intangible assets, retirement savings and estate plans.
In weighing such a serious decision, we advise individuals to work with knowledgeable and experienced professionals with expertise in the legal and tax ramifications of expatriation before taking action.
The term "expat" is widely used to describe the U.S. citizen who is living abroad on a work assignment either temporarily or for an indefinite period of time. The term should not be confused with the statutory "expatriate" of the U.S., who is a person that has renounced his or her U.S. citizenship.
The U.S. tax system taxes its citizens on their worldwide income regardless of where they reside. For instance, a U.S. expat residing in Hong Kong will still be subject to U.S. income tax and other taxes for income earned in Hong Kong. This tax regime, and the increasingly complex reporting requirements associated with it, are particularly burdensome for the significant number of Americans who are U.S. citizens merely because they were born in the U.S. or had an American parent, but who have lived most of their lives abroad and have no intention of returning to the U.S.
The number of U.S. citizens who are relinquishing their citizenship is on the rise. In 2008, there were 2351 such cases. By 2015, that number had risen to 5,9862. This increase in volume prompted the U.S. State Department to raise the fee for expatriation to almost five times the previous price, from $450 to $2,350, effective September 12, 2014.3
The Rules of Renunciation
After many decades of changes and refinements to the IRS tax code, the rules as of 2016 say that any individual who renounces citizenship and has a net worth of $2 million or more, or an average income tax liability of $161,000 or more for the five preceding years, is presumed to have done so for tax-avoidance reasons.
In such a case, the expatriate would be treated as if they had liquidated all their worldwide assets on the date prior to their expatriation. The net gain of this liquidation is subject to an exit tax if it exceeds $693,000. The gain is calculated by deducting the expatriate's cost basis from the theoretical sales price of their assets.
Specified tax-deferred accounts — such as IRAs, certain education and health savings accounts, and interests in non-grantor trusts — are excepted from this immediate exit tax, although a 30% withholding tax will be taken from future distributions, where applicable.
In addition, expatriates that meet the criteria for tax avoidance ("covered expatriates") are still subject to the U.S. wealth transfer tax for as long as they live (and sometimes beyond if transfers are made to a foreign trust). The IRS has also instituted a new rule that taxes the recipient of gifts or bequests from these expatriates. This tax is imposed at the highest marginal rate, although it may be reduced by any gift or estate tax paid to a foreign country.
In a further variation from the standards most advisors are familiar with, the gift tax for expatriates is tax inclusive, not tax exclusive. So the recipient of the gift will pay a gift tax on what is received above whatever exemption may have been used. It is important to be aware that the recipient of gifts from covered expatriates is only entitled to shelter one annual exclusion gift received from covered expatriates. So if the parents of a gift recipient make gifts of $28,000 to him or her, the child is liable for a gift tax on the $14,000 that exceeds the annual gift exclusion.
The wealth-transfer tax is imposed on all of the covered expatriate's wealth, even if generated after the individual expatriates. It is not limited to the exit tax imposed at the time of expatriation; it also applies to inherited wealth after expatriation. So if an expatriate's foreign-national parent leaves everything outright to that individual without sufficient planning, the bequest will be subject to that individual's estate tax on the property he or she passes to U.S. persons.
The Importance of Planning Ahead
These excess transfer taxes may be mitigated by planning ahead. Before a person decides to formally expatriate, there is a planning opportunity to eliminate the tax-inclusive aspect of general gifting or of bequests at death to a U.S. citizen. It is important for individuals to use their exemption amounts to the greatest extent possible before expatriating. This, of course, assumes an individual can afford to part with property. The usual considerations in wealth-transfer planning should be weighed carefully, including whether the gift should be made outright or in the form of a trust. It is always important to understand a property's format, such as whether it is in LLC, FLP, individual or joint name form.
It can be a good idea to establish a dynasty trust in a state like Delaware. Doing so enables a donor to protect a sizeable proportion of his or her assets in a trust that can continue to benefit many future generations of descendants that are going to remain U.S. citizens. The trust should be drafted in a flexible fashion so that it can address unforeseen issues. For example, if a member of a future generation were to expatriate, the donor may be able to shelter that portion of the trust from the future expatriate's assets.
When it is not clear whether an individual will formally renounce citizenship, it may be wise to create an irrevocable life insurance trust for the benefit of that individual's spouse and descendants. If the individual never renounces citizenship, the money will be available to pay any estate tax. If he or she does eventually renounce citizenship and still has assets at death that are subject to estate tax, the money will also be available.
Critically, formal expatriation is only available to those who are not delinquent on their U.S. taxes. Thus, the first step for those planning to expatriate is to become compliant. In these cases, professional guidance is highly recommended, as detaching oneself from the U.S. IRS is much more complicated than is commonly believed.
Expatriates who have failed to certify that they were fully compliant with all U.S. tax requirements for the five years prior to expatriation are also subject to the exit tax and ongoing gift and estate tax liabilities. Expatriates who come back to the U.S. and reside there for at least 31 days in any year during the 10 years after their formal expatriation run the risk of becoming fully subject to taxes again in the U.S., as if they are U.S. citizens.
It is important to note that expatriating under U.S. immigration law does not necessarily remove a U.S. person from long-term permanent resident status for federal tax purposes. A long-term, permanent resident continues to be subject to U.S. taxation until his resident status has been officially rescinded through a judicial or administrative order, or until another country informs the IRS that it has started to treat that person as a resident under the provisions of a tax treaty with the U.S. Similarly, a U.S. citizen who is expatriating must complete a formal process with the IRS to sever his tax obligations to the U.S.
The legal and financial complexities of relinquishing one's citizenship or green card should give any prospective expatriate pause before taking action. Consulting with knowledgeable tax and wealth planning professionals with sophisticated global expertise is imperative.
Some Famous Americans Who Have Renounced Their Citizenship
The Health Insurance Portability and Accountability Act (HIPAA) requires the IRS to post a list of citizens who voluntarily expatriate or abandon their American citizenship during the course of the year. Some of the more notable expatriates in recent years have been:
- Edward Tupper (Founder of Tupperware)
- Kenneth Dart (heir to the Dart Container Corporation dynasty)
- Eduardo Saverin (Facebook co-founder)
- Denise Rich (Socialite and former wife of pardoned tax cheat, Marc Rich)
- Andreas Papandreous (Later became Prime Minister of Greece)
- Tina Turner (Actor)
- Jet Li (Actor)
- Ted Arison (Founder of Carnival Cruise Lines and owner of the Miami Heat NBA franchise)
- Bobby Fischer (Chess grandmaster)
The Reed Amendment ("The Benedict Arnold Rule")
One thing that expatriates may want to keep in mind is the possibility of the application of the Reed Amendment, or "the Benedict Arnold Rule," as it is sometimes called. Created by the Illegal Immigration Reform and Immigrant Responsibility Act of 1996, it provides that former citizens of the U.S. who have renounced their citizenship to avoid taxation are of "classes of aliens ineligible for visas or admissions." The result is some former citizens may be barred from returning to the U.S. While there have been serious questions about its constitutionality, and enforcement appears dubious at best, individuals should be careful to ensure their expatriation is not solely to avoid U.S. taxation. Thus far, the Reed Amendment has never been enforced to bar entry to the U.S. to a former citizen because of tax reasons.