You may be leaving the United States, but you cannot relinquish your tax liabilities. In an effort to discourage US citizens from renouncing citizenship for tax avoidance purposes, the Internal Revenue Service imposes upon expatriates a tax known as the expatriation tax, or exit tax. It doesn’t matter if you’re a US expatriate living in Lebanon, Greece, Singapore, Switzerland, or anywhere else in the world – you must comply with exit tax requirements if you wish to avoid penalization.
Who is Subject to Exit Tax?
In 1966, Congress passed legislation permitting for taxation of former US citizens under IRC Section 877, which provides that former citizens may be taxed for up to a decade following renunciation of citizenship. IRC Section 877 was amended in 1996 by the Reed Amendment, and once more in 2004 by the American Jobs Creation Act (AJCA). The current version of the exit tax was revised in 2008.
The provisions of IRC Section 877 apply to two groups of taxpayers:
- “US citizens who have renounced their citizenship” (i.e. expatriates).
- “Long-term residents who have ended their US resident status for federal tax purposes.”
- This refers to green card visa holders who terminate residency after holding a green card for at least eight out of the past 15 tax years.
If you belong to either of these categories, you are subject to exit tax.
Put simply, exit tax is an income tax. Assets held by an expatriate (or green card holder) will be treated as though they were sold the day before the individual renounced his or her citizenship or US resident status. Profits resulting from the “sale” are taxed. This is provided by IRC 877(d)(2)(A), which states the following:
“Such property shall be treated as sold for its fair market value on the date of such exchange, and any gain shall be recognized for the taxable year which includes such date.”
This is sometimes referred to as mark-to-market.
If the “sale” results in a loss, the loss will be “taken into account for the tax year of the deemed sale,” notwithstanding specific exceptions provided by federal law.
Who is a Considered a Covered Expatriate?
The date you expatriated will determine whether you are classified as “covered expatriate.”
The most recent date range covers individuals who expatriated from the United States on or after June 17, 2008. If you expatriated in the past few years, or if you are planning on leaving the US in the near future, you are a covered expatriate if any of the following descriptions apply to you:
- On the date you expatriated or terminated residency, your net worth was valued at last $2,000,000.
- For the five years before you expatriated or terminated residency, your average annual net income tax was exceeded the following limits:
- $147,000 in 2011
- $151,000 in 2012
- $155,000 in 2013
- $157,000 in 2014
- Expatriates are required file Form 8854 (Initial and Annual Expatriation Statement) to certify full compliance with the Tax Code, dating back to five years before the date or expatriation or termination of status as a US resident. If you fail to file this form and certify your compliance, you are a covered expatriate.
- Note that, depending on the circumstances, failure to comply with tax laws can also result in the imposition of civil penalties and/or criminal prosecution by the Department of Justice. In particular, the IRS and DOJ have become increasingly watchful with regard to taxpayers who attempt to conceal income and assets in offshore bank accounts held with foreign financial institutions (FFIs).
If you are a covered expatriate, you need to think carefully about the tax implications of making a gift or leaving an inheritance to a US citizen. Unfortunately, your status as a covered expatriate means that if you do choose to make a gift or bequest, the recipient will also be subject to an extremely hefty 40% tax on that gift or bequest. Your CPA can help you weigh the financial considerations when it comes to leaving an inheritance to a loved one in the United States.
If you’re planning on expatriating from the United States, it’s extremely important to review your tax liabilities with an experienced CPA prior to renouncing your citizenship. The provisions of IRC Sections 877 and 887A are expansive, and failure to comply in a complete and timely manner can result in harsh penalties. To set up a free and confidential consultation with CPA Ted Kleinman, call US Tax Help at (800) 810-9312 today.