Renunciation of Citizenship and Termination of Long Term Resident Status
Should I Stay or Should I Go?
With the recent 2016 presidential election behind us, some U.S. citizens and long term permanent residents have declared that they are leaving the U.S. for greener pastures. If you have decided to join the legions of entertainers, athletes and others who have threatened to leave the United States, there are certain things you need to know. There is a very good reason why some of the liberal elite have walked back their threats to expatriate, while others have either gone silent or offered up a lame excuse. In any event, they are not leaving. Why? It’s the Exit Tax!
The decision to expatriate is life altering and should only be made after carefully considering both the quantitative and qualitative factors and after consultation with an experienced tax attorney. The following information is intended to provide you with a general outline of the requirements for expatriation as well as the potential impact of the Exit Tax. There are other considerations including the political risk associated with living in a foreign country, potential barriers to re-entry to the U.S. in the event of a political instability, cultural differences, language barriers, the potential infringement of civil or human rights and many others. The message is walk slowly.
What is Expatriation?
In general, the act of expatriation is considered the act of withdrawing oneself from residence from one’s native country. For federal income tax purposes the act of expatriation is a broader concept and depends upon the individual’s legal status as well as his or her date of expatriation. Technically, a U.S. citizen expatriates through the process of renunciation while a long term resident ceases being a long term resident based upon certain events. For purposes of this discussion, we will use the term “Expatriate” to include both U.S. citizens as well as long term residents.
U.S. Citizens. Expatriation for a U.S. citizen occurs on the earliest of four possible dates:
- the date the individual renounces his or her U.S. nationality before a diplomatic or consular officer of the United States, conditioned upon the issuance to the individual of a certificate of loss of nationality by the U.S. Department of State.
- the date the individual furnishes to the U.S. Department of State a signed statement of voluntary relinquishment of U.S. nationality confirming the performance of an act or expatriation specified in paragraph (1), (2), (3) or (4) of section 349(a) of the Immigration and Nationality Act, subject to approval as evidenced by the issuance to the individual of a certificate of loss of nationality by the U.S. Department of State.
- the date the U.S. Department of State issues to the individual a certificate of loss of nationality, or
- the date a U.S. court cancels a naturalized citizen’s certificate of naturalization.
Long Term Residents. A long term resident will cease being a lawful permanent resident if:
- the individual’s status as a long term resident has been revoked or has been administratively or judicially determined to have been abandoned, or
- the individual:
- commences to be treated as a resident of a foreign country pursuant to provisions contained in a tax treaty between the United States and the foreign country,
- does not waive the benefits of the treaty applicable to residents of a foreign country, and
- notifies the IRS of such treatment on Forms 8833 and 8854.
What’s a Covered Expatriate?
A U.S. citizen who renounces his or her citizenship or a long term resident who terminates his or her U.S. resident status may be subjectto what is sometimes referred to as the ”Exit Tax”or the “Expatriate Tax.” The Exit Tax only applies to a “Covered Expatriate.”. A U.S. citizen or long term resident is considered to be a Covered Expatriate if any of the following apply:
- Your average annual net income tax for the preceding 5 tax years ending before the date of expatriation or termination of residency is more than a specified amount adjusted for inflation. ($151,000 for 2012, $155,000 for 2013, $157,000 for 2014, $160,000 for 2015 and $161,000 for 2016).
- Your net worth is $2million or more on the date of expatriation or termination of long term residentstatus, or
- You fail to certify on Form 8854 that you have complied with all U.S. federal tax obligations for the five years preceding the date of your expatriation or termination of your residence.
If a citizen or long term resident is considered a Covered Expatriate, the IRS will treat the individual’s property as if it were sold for its fair market value on the day before the expatriation date, using a mark to market approach. Any gain or loss from the “deemed” sale is considered to have occurred in the tax year where the act of expatriation has taken place. Wash sale rules, however, do not apply.
The Covered Expatriate is subject to income tax on the net unrealized gain from the sale ofthe individual’s property. The total amount of gainis reduced by an exclusion amount which is adjusted for inflation. (The following exclusions apply: $690,000 for 2015; $693,000 for 2016). The net gain, after allowance for the exclusion,is subject to income tax at the capital gains rates. The capital gains rate will vary depending upon the individual’s federal income tax bracket. Individuals in the 10% or 15% tax bracket pay nothing. Those in the 25% and 35% tax brackets will pay a capital gains rate of 15. Finally, those in the highest bracket of 39.6% will pay a capital gains rate of 20%. In addition single filers earning more than $200,000 and joint filers earning more than $250,000 may also have to pay an additional 3.8 “Net Investment Income Tax.”
Calculation of Capital Gains Tax
To illustrate how the Exit Tax works,consider the following example.
John Howard is age 54. John is a famous Philadelphia criminal attorney and long term Clinton supporter. John is disgusted with the election results and simply cannot stand the thought of a Trump Presidency, much less a Republican majority in the House and Senate. John decides to renounce his U.S. Citizenship and move to Kenya, where he has accepted a position as an adjunct professor of law at the University of Nairobi, College of Law. John is married to a Kenyan national and previously secured permanent resident status.
John has done extremely well in the stock market, having amassed a portfolio valued at $82 million. In addition, John owns a condominium in downtown Philadelphia, a mountain home in the Poconos and rare collection of Native American artifacts. John also owns a collection of vintage motorcycles including a 1948 Indian Chief, a 1943 Harley Davidson “Knucklehead” and a 1952 Harley “Panhead.” Finally, in 2013 John inherited the family ranch in Chama, New Mexico consisting of 3,000 acres of pasture land, a main and guest house, 2 barns,servants’ quarters and 300 head of cattle. The fair market value of the Chama Ranch at the time of his mother’s death was $8,420,000.
Without first consulting with a tax attorney, on November 13, 2016 Johnrenounces his U.S. citizenship.The fair market value of John’s assets, tax basis and tentative gain are as follows:
|Asset||Fair Market Value||Basis||Gain/Loss|
|Native American Artifacts||1,675,000||227,300||1,447,700|
|1948 Indian Chief||68,000||18,250||49,750|
|1943 Harley Knucklehead||39,000||22,875||16,125|
|1952 Harley Panhead||23,418||12,222||11,196|
|Chama, NM Ranch||9,275,000||8,420,000||855,000|
John is in the highest tax bracket of 39.6%. As such, he will be taxed at a capital gains rate of 20% and will also be subject to the 3.8% net investment income tax. As the following calculation demonstrates, leaving the country may not be such a great idea. Perhaps those in the entertainment industry are on to something!
|Capital Gains Tax @ 20%||$7,214,954|
|Net Investment Income Tax @ 3.8%||$1,370,841|
|Total Exit Tax||$8,585,795|
Payment of the Tax
If you expatriate in 2015 or later, it may be possible defer payment of the mark to market tax on any property deemed to have been sold. The deferral is on a property by property basis. Taxpayers interested in deferring the tax are required to enter into a tax deferral agreement with the IRS. In addition, the taxpayer must furnish security in the form of a bond or letter of credit acceptable to the IRS that will cover the assessed tax plus accrued interest. The rationale behind securing the payment of the tax debt with a bond or letter of credit has to do with leverage and the potential risk that the expatriate might skip out without paying.
What are the Post Expatriation Tax Benefits?
A U.S. citizen or long term resident, who successfully expatriates is no longer subject to U.S. income tax on the expatriate’s worldwide income and no longer required to file a U.S. tax return. But not so fast! A former citizen or long term resident of the United States is still subject to U.S. tax on any income derived from U.S. sources including income from any U.S. trade or business as well as income derived from investment such as stock, bonds, real estate, etc. The expatriate may also be subject to withholding on any U.S. income and required to file 1040NR. Finally, an expatriate may be required to file certain financial reports with respect to any ownership interest in a U.S. entity.
What Happens if I File a False Certification? — Are They Really Going to Come after Me?
Just ask Dan Horsky, who on November 4, 2016 pleaded guilty to conspiracy to defraud the United States and submitting a false expatriation statement in 2014. According to documents filed with the court, Horsky, age 71 is a U.S. citizen and also a citizen of the United Kingdom and Israel. Horsky was employed by a Rochester, New York University as an emeritus professor of business administration for over 30 years. From 1995, the defendant engaged in a pattern of nefarious activity which included investing in startup companies by using funds from unreported foreign financial accounts, creating a foreign nominee entity for the sole purpose of holding title to the shares in his investments and setting up a foreign bank account in the name of a nominee entity in order to conceal his financial transactions and financial accounts from the IRS. As part of the scheme Horsky failed to report substantial income received from his offshore investments. Details of the conviction can be found at: https://www.justice.gov/opa/pr/emeritus-professor-pleads-guilty-conspiring-defraud-united-states-and-submitting-false
While the Horsky case deals with a false certification in the context of the failure to report foreign income and foreign financial assets, the concept of falsifying Form 8854 with respect to domestic assets equally applies. The other takeaway here is that the IRS will hunt down an expatriate, no matter how remote the location, if the expatriate submits a false Form 8854 and the IRS subsequently finds out.
In conclusion, any decision to leave the United States permanently should not be made without carefully considering the tax implications and without speaking with a tax attorney. Other factors, such as political risk of expatriating to a foreign country, cultural differences, language fluency, and barriers to reentry to the U.S. in the event of political upheaval should also be considered. Finally, given the political uncertainty with respect to the future enforcement of the U.S. immigration laws, an expatriate should consider the possibility that he or she may not be able to get back into the United States, even on a travel visa, if it doesn’t work out.It might not be a bad idea to first rent, before buying the farm.