The International Family with a US Connection
Renouncing US Citizenship (“USC”) – A Cost/Benefit Analysis.
see also Exit
As the IRS continues its crackdown on “offshore” reporting failures, many USCs living abroad will be re-evaluating their USC (or perhaps discovering for the first time that they are USC). This is obviously a serious decision, you are giving up a substantial bundle of legal rights, and citizenship is not something you can get back without serious difficulty and significant cost. On the other hand, our politicians continue to make it more difficult for those USCs with limited ties to the US to keep USC.
The Context. Many of our USC clients have very tenuous ties to the US, however, they have full US tax payment and reporting obligations. Some have absolutely no ties to the US other than the accident of birth. Most countries do not tax their citizens who are not physically resident – the US is the exception and that is the root of the problem.
For example, UK residents who depart the UK and limit physical visits are relieved from tax obligations and can obtain a formal “no tax” code, while keeping their British passports. That is not possible under US rules.
In addition, the segment of USC’s abroad that is being discussed here, are not “tax-dodgers”, they do not live in tropical island tax havens, they live in high tax advanced economies.
It is impossible to come up with a formula to help simplify the decision whether to renounce – there are too many subjective elements. However, these are the factors that most of our clients focus on:
Overall Tax Liability. This is usually the first consideration. Is my overall tax bill higher because I hold on to my US passport? In most cases, the answer is no, as tax rates in many advanced economies exceed US tax rates and US tax is eliminated by foreign tax credits. Due to the global recession this relationship may be changing as some countries reduce tax rates to jump start their economies, while the US with it fiscal deficits is likely to increase tax rates.
Cost and Stress of US Tax Compliance. There is the annual cost of professional fees for filing expatriate tax returns and international information returns indefinitely In addition, there is the added stress to already harried professional lives of living with additional tax deadlines (especially in light of the substantial penalties, typically $10,000 for simple reporting failures). For many this is the key cost factor.
Estate Planning. You must plan your affairs (wills/trusts etc.) around at least two sets of laws, which typically involves two sets of legal advisors. However, if your estate is within the US exempt amount (currently $3.5 million but Congress may lower to $1 million next year) such complications are significantly reduced. If your estate exceeds the exempt amount and your spouse is not a USC, and is unlikely to become one, you will likely have to use what is known as a QDOT trust – which is something to avoid.
International estate planning is discussed in greater detail elsewhere on our website.
Conferring US Immigration Benefits on Close Family
Members. Historically, this has been a significant consideration but as the US economy becomes less important relative to the balance of the world, it is destined to become less so. Nevertheless, both LTR’s and USC’s are well placed to sponsor other close family members into the US.
Returning to the US (Immigration Issues). A frequently asked question is whether you will encounter any problems returning to the US as a visitor. After renunciation you will either rely on the visa waiver program (if country of nationality is part of the US visa waiver program) or you will obtain a visitor visa. In either case, you must not be ineligible to enter the US. Tax avoidance, in the criminal sense, may be a crime of moral turpitude. This can be a barrier to entry. In the situations we are discussing, tax avoidance – in any morally negative sense - is not at an issue. In addition it is anticipated that these individuals will comply with the “exit tax” procedures discussed below.
You should be aware of an obscure law known as the “Reed Amendment” which bars entry into the US if you left for reasons of tax avoidance. The law has never been enforced and suffers from many unaddressed legal and constitutional issues but you should be aware of its existence.
Based upon current law, if you have children who are USC and chose not to renounce, should your circumstances change, those children, upon turning 21, can sponsor you for a green card in the future.
Finally, the US Exit Tax (discussed below) may impose a significant cost on those leaving the US legal and tax system.
USC – “Renunciation” before a US consular officer is the most direct method of losing USC. An appointment for an
interview must be made with your local consulate. Wait times vary, but anticipate a several month wait. You will have an interview wherein you will formally renounce then wait for final certificate of Loss of Nationality, which will relate back to your interview date as the effective date. You will also need to file Form 8854 (discussed below) with IRS. The latter of date of filing this form or the interview will determine when you exit the US tax system.
Your name will be published in the Federal Register, which is a public document.
LPR – A form I-407 “Abandonment by Alien of Status as Lawful Permanent Resident” should be filed with the local US consulate. Proof of mailing is advisable. In most cases it will take the State Department around 30 days to process the application but you will exit the US tax system as of the filing date. Alternatively, your green card can be surrendered to a border officer (obtain proof of receipt). Filing a US tax return taking a treaty-based position claiming non-residence for US tax purposes will also result in a deemed abandonment of your green card. In either case, a Form 8854 must also be filed to terminate tax residency.
The US Exit Tax
US politicians typically view those USCs or long term residents who leave the US tax system
(“expatriates”) as wealthy “tax dodgers” who are about to run off to some tax haven with their millions. However, in our experience the vast majority already reside in a high tax jurisdiction and pay full tax on all their income. These individuals just want to simplify their lives and limit exposure to some of the hefty IRS penalties that lay in wait should they fail to file a tax form on a timely basis. To discourage expatriation Congress passed Code section 877 originally in 1966. There have been several modifications since, the latest being legislation known as “HEART” (Code section 877A) effective for expatriations after June 17, 2008.
The Objective Thresholds
First you must either be a USC or LTR (LTR’s are those LPR’s who have held their green cards in at least 8 years in a 15 year lookback period, otherwise these rules do not apply to you).
Then if your average tax liability for the five preceding tax years has exceeded $139,000 (adjusted annually for cost of living) or your net worth exceeds $2 million you are subject to taxation under either Section 877 or 877A depending upon date of expatriation.
All expatriates must file Form 8854 upon expatriation. Those subject to tax under 877 or 877A must file the complete form.
As part of this process, you must certify that you have fulfilled your US tax obligations for the past five years. This must be done by all expatriates on Form 8854.
Expatriation Pre- June 17, 2008
You will have to pay US tax on certain US source investment income (including certain US source income realized by controlled foreign corporations) realized during the 10 years following expatriation. This category of income would not otherwise be taxed in the hands of a nonresident alien. Inconsistent treaty provisions are overridden by this legislation.
You must file Form 8854 annually.
Expatriation Post – June 16, 2008
The 10 year clawback taxation of US source income has been replaced by a deemed sale (mark-to-market) of all your property the day before your date of expatriation. You are given a $600,000 exempt amount, gains in excess of that sum are taxable. Pensions and deferred compensation plans are subject to special rules.
If you return to the US for more than 30 days in a given year (60 if traveling on behalf of an unrelated employer) you are US tax resident for the entire year and any conflicting tax treaty provision is overridden.
You will have to provide an information statement for each year you have any obligations under this new tax regime.
USC or residents who receive gifts from an expatriate will be subject to a transfer tax of 45%. For those with limited ties to the US, this new tax may not be of concern.
Certain deferred compensation arrangements (pensions etc.) will be subject to 30% withholding. These arrangements are limited to those subject to US withholding – US plans. Other arrangements, for example foreign pensions, are treated as received (present value) the day before expatriation.
Payment of the exit tax can be deferred by payment of bond (or other security arrangement). Interest will be charged.
Statutory Exceptions to Sec.
877A Exit Tax
Regime. If you otherwise fall within the financial thresholds set out above and certify that you have fulfilled your tax obligations for the past 5 years you can escape the Sec. 877A tax regime if you became a dual citizen at birth, you retain that other citizenship, and you are currently a tax resident of that country or you expatriate by age 181/2 and in the last 15 years you were not US resident (under substantial presence test) more than 10 years.
The Inadvertent USC. Many individuals have become USC by birth in the US or birth abroad to a USC parent (the rules here are complex) but otherwise have few or no ties to the US. We call these individuals “inadvertent USC”. The IRS has set out procedures that provide for discretionary relief from the office of the Assistant Commissioner International for individuals who are USC but did know they were USC and never exercised the rights of US citizenship. To date, these procedures have not been coordinated with Sec. 877 or
The individuals we are discussing likely pay full tax in their country of residence. Given the treaty override (tax treaties are designed to eliminate double taxation), the possibility of double taxation must be addressed.
For those who have doubts about the value of continuing to hold a US passport given their tenuous ties to the US a thorough review of the US expatriation rules is well advised.
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website is for informational purposes only and does not
constitute tax or legal advice. Such advice can only be
provided with full knowledge of your particular facts and