Living and working in the US is undoubtedly attractive but for a variety of reasons you may decide to call it a day, reuniting with family or simply pursuing other opportunities abroad. Yet keeping your green card or US citizenship when you’ve settled abroad may imply intrusive, annual US tax filings even though you’ve left the country.
Ongoing tax filings is one reason why at first glance it may look sensible for those leaving the US permanently to renounce US citizenship or to forfeit their green card. But doing so can carry tax implications in the shape of expatriation tax. However, not everyone is subject to expatriation tax, and those who are can carry out tax planning strategies to reduce their exposure.
What is expatriation tax?
In the context of US personal tax law expatriation tax, also known as exit tax, is a tax filing procedure that needs to be completed by some individuals who give up their US citizenship or green card. The exit tax process measures untaxed income and delivers a final tax bill. Paying exit tax ensures your taxes are settled when you cease to be a US tax resident.
Why does exit tax exist?
Exit tax is not charged out of mean-spiritedness or as a final grab at your personal assets. Instead, exit tax is an attempt by the US government to consolidate your US tax affairs. Exit taxes are relevant because some “taxable income” such as capital gains on home ownership is not taxed until you dispose of the asset.
Asset disposal may only occur decades after you’ve permanently left the US while some of the capital gains occurred while you are a US tax resident. Once you fully leave US jurisdiction the US can no longer pursue you for taxes, which is why the US government may require an exit tax filing.
Who is subject to exit taxes?
Leaving the US permanently does not necessarily imply that you need to file for exit taxes. Falling under the exit tax regime hinges on two factors: your immigration status, and your personal finances: your income, assets and tax compliance history.
Comprehensively covering the rules around exit taxes lie beyond the scope of this article, we strongly suggest that you read the IRS instructions for filing form 8854 (filing for exit taxes) or even better, obtain professional tax advice. However, we can summarize the requirements as follows:
A couple of years as US tax resident won’t leave you subject to exit taxes, but broadly speaking holding US citizenship will. If any of the following two criteria apply to you, you may face an exit tax bill:
US citizenship. If you are renouncing your US citizenship the IRS will most likely require you to consolidate your tax affairs via the exit tax process. However, most of our readers are immigrants and it is worth noting that individuals who acquired US citizenship while holding citizenship from a different country by birth may be outside the exit tax regime. That said, the next point may still catch you
Long-term residence. Living lawfully in the US as a permanent resident (whether on a green card or as a US citizen) for eight out of the fifteen years ending with the expatriation year may mean that you are subject to exit taxes. Again, exceptions apply including years where a green card holder has requested to be treated as a non-resident alien for a given calendar year
If you’re neither a US citizen nor a long-term resident you don’t need to worry about exit taxes. Falling under either category, however, may make you a “covered expatriate”.
Your personal tax situation
As a US citizen or long-term resident you need to file form 8854, which determines whether you are a “covered expatriate” and subject to the exit tax regime. You are a “covered expatriate” if you meet one or more of the following three conditions:
Personal net worth. Your personal net worth is more than $2 million at the date of expatriation. Note that some assets are excluded from the calculation: your retirement plan may be omitted, for example
Personal tax liability. The average annual net income that you are taxed on for the five years before you expatriate is more than a set amount. The amount is adjusted by inflation, 2018’s figure is $165,000. Note that the amount refers to net income, any deductions that reduce your tax burden reduces the net income figure
Tax compliance. You fail to certify on form 8854 that you have complied with all the required federal tax obligations for the past five years. In other words, by not ticking the box you admit that your personal taxes are not fully settled with the federal government – undeclared income may be at issue, for example
As a “covered expatriate” your personal financial affairs will undergo final scrutiny by the federal government, resulting in a final tax bill which may be significant, or indeed of little consequence.
How much exit tax will I pay?
Again, the US government wants to get its fair share of untaxed income. The amount you are due to pay will be dependent on the structure of your personal assets, unrealized capital gains is really where exit taxes come into play. Income such as salaries and investment returns are generally taxed on an annual basis, expatriation tax is not an attempt to tax you a second time.
In determining the amount of tax to be paid the IRS will base its tax evaluation on the fair market value of your assets. In other words, the IRS taxes you on the capital gains should you sell your assets on the date of expatriation.
There are exceptions to the market-value rule, including the treatment of 401(k)s and the distributions from some trusts, these future distributions will be taxed as they are paid.
Can “covered expatriates” avoid exit tax?
Intelligent financial management involves minimizing personal tax exposure. Awareness of the existence of the exit tax regime is an important first step.
With this knowledge, you can arrange your financial affairs to minimize your exposure to exit taxes. We cannot comprehensively cover exit tax strategies, but we can offer some examples:
Consider distributing your assets to your spouse. The $2 million personal net worth criteria are applied individually, you can transfer assets to your US citizen spouse without paying gift taxes
Attempt to keep your annual net income below the threshold
Avoid staying in the US long enough to fall under the eight years out of fifteen years residency rule
Try to minimize capital gains by, for example, transferring ownership of a home to your spouse while holding on to other assets such as cash yourself
Expatriation taxes and the filing thereof are complex. You don’t need to be concerned if you are clearly outside of the exit tax rules due to your immigration status or personal finances.
If that’s not clear, however, or if you are obviously required to file for exit taxes we strongly recommend that you seek expert advice.