Over the last few years, American passport holders have been renouncing their citizenship like no other time in history. During the first six months of 2020, almost 6,000 Americans gave up citizenship – a 1210% increase compared to the prior six months, during which only 444 cases were recorded. Before the current pandemic, these numbers had been in decline. This new trend looks to continue into 2021 as many Americans anticipate the impact of President Biden’s proposed tax reform package.
Tax Proposal Projections on Income Taxes
The United States is unusual in levying personal income tax on all citizens regardless of country of residence. Citizens of the U.S. living abroad are required to file U.S. taxes each year and report all foreign accounts held outside the country. Some individuals see this as a hardship that is simply not worth the hassle. Beyond the compliance burden, many wealthy U.S. citizens are also concerned about the potential negative impact of certain aspects of Biden’s tax proposal including:
- Increase in tax rate on long-term capital gains and ordinary income
- Reduction in estate tax exemption (from $11.7M to $3.5M per individual)
- Elimination of basis “step-up” at death for inherited property
- Elimination of short-term grantor retained annuity trusts (“grats”)
- Additional eligibility requirements to participate in 1031 “like-kind exchanges” involving real estate assets
Renouncing U.S. Citizenship
Before one considers renouncing their citizenship, they should know that it’s not a decision to be taken lightly. U.S. citizenship comes with major benefits, such as:
- The right to live and work in the United States
- The right to travel to (and throughout) the United States
- The right to vote in U.S. elections
- Access to consular services abroad
- Access to protection abroad
While there are definite tax benefits to renunciation (after the State Department approves an application, they issue a “Certificate of Loss of Nationality” (COLN) which severs an individual’s U.S. tax filing duties), there are also important consequences to consider:
- It can become difficult to travel to the U.S. This is especially important to keep in mind if one is hoping to eventually move back to see family or take care of sick relatives.
- Potential to be without a state: Those renouncing citizenship must already possess a passport from another nation or risk becoming stateless.
- Negative publicity: Every quarter, the names of individuals who renounce their U.S. citizenship are published in the Federal Register.
- Legal implications: One could find themselves facing legal ramifications if the Department of Homeland Security determines that the renunciation is motivated by tax avoidance purposes (and could be barred from reentering the country).
- Impact on children: While children do not lose citizenship when a parent renounces, a child born abroad to a former U.S. citizen does not automatically gain American citizenship.
- Irreversible consequences: Giving up U.S. citizenship is irrevocable.
- Weapons mandate: Expatriates cannot purchase or possess firearms in the U.S.
U.S. Exit Tax
Certain individuals deemed “Covered Expatriates” renouncing citizenship or relinquishing their Green Card within the last ten years must also pay an “Exit Tax.” Covered Expatriates are former U.S. citizens whose average tax liability is above $171,000 or their net worth is above $2 million (or if they have been deemed noncompliant in the past). The Exit Tax is a “Mark-To-Market” tax on most assets, except for certain items of deferred compensation, specified tax deferred accounts and non-grantor trusts, and it’s based on the fair market value (FMV) of these applicable assets. This tax also applies to Green Card holders who are “Long Term Residents,” meaning they held a Green Card and were U.S. Residents for eight out of the last fifteen years.
As described above, “Covered Expatriates” calculate their U.S. Exit Tax using Form 8854, which is based on a “deemed sale” of the taxpayer’s assets on the day prior to expatriation. The resulting gains would be subject to U.S. tax following regular income tax principles, where maximum tax rates of 23.8% apply to Long-Term Capital Gains and 40.8% on Other Gains would apply.
Although many Americans are motivated to expatriation in an effort to minimize their U.S. tax liability and compliance costs, it is important to note that many of the U.S.’s closest trading partners impose even higher personal taxes on high earners such as Mexico, Canada, United Kingdom, France, Ireland, Germany, South Korea, Vietnam and South Africa.
If you are considering expatriation, it is important to seek experienced legal and tax planning advice so that you can fully understand how each step in the process will affect you personally. Professionals can assist you with different planning options, such as:
- Sale of primary residence
- Gifting and Estate Planning (including timing considerations)
- Limited Partnerships and Valuation Discounts
- Pre or post-nuptial agreements, and inter-spousal gifting
- Relocation to Puerto Rico or the US Virgin Islands as a Bona Fide Resident without renouncing U.S. Citizenship
Bennett Thrasher’s Individual Tax practice helps clients navigate these complexities and ensures that they are in compliance. To learn more about our services, contact Michael Klug or Chris Benner by calling 770.396.2200.