Recently there has been an increased interest surrounding expatriation by US citizens. While some individuals may choose to expatriate for personal or ideological reasons, there are also a number of practical and financial considerations that can drive the decision to leave the U.S. and its tax system.

Keep in mind that the U.S. is one of the very few countries in the world that taxes its citizens on worldwide income regardless of where they reside. The often burdensome rules of tax and foreign disclosure requirements applies to citizens living abroad as well as the so called “accidental Americans” who may have never even set foot onto American soil. Here’s what you should know.

The exit tax and expatriation rules

While there are various mechanisms within cross border tax rules that serve to mitigate double taxation such as foreign tax credits and treaty relief such systems are imperfect and do not alleviate the administrative burdens of complying with U.S. tax rules.

While many are somewhat familiar with the current expatriation regime (2008 and after) that imposes an “exit tax” on certain high net worth individuals who are leaving, it’s important to note that previous expatriation tax rules date as far back as the 1960s. The common denominator of all these predecessor regimes was to impose a tax on those expatriating for tax avoidance purposes.

Tax avoidance

Tax avoidance usually took one of two forms.

1. First someone could renounce citizenship and depart the U.S. tax system without being up to date on their U.S. tax filings (or never filed for that matter).
2. Secondly, they could avoid later tax on unrealized appreciation on their assets. So, while these rules evolved though the years, the current version of the expatriation tax is effective for individuals leaving the system on or after June 17, 2008.

With this background in mind let’s look at five key points on the mechanics of these current rules.

1. The expatriation provisions apply to both U.S. citizens as well as certain long-term residents / green card holders who are deemed to be “covered expatriates.” More specifically green card holders who have held that status for eight out of the last fifteen years are potentially subject to the exit tax.
2. The determination of covered expatriate status is made by filing IRS Form 8854 with one’s final tax return. One is a covered expatriate if any of the following applies:
   - Tax liability- Average net income tax for the 5 years ending before the date of expatriation was more than $201,000.
   - Net Worth -Over $2 million on the date of expatriation
   - Prior tax compliance- Failure to certify that in compliance with all federal tax obligations for the 5 years preceding date of expatriation
3. If one is deemed to be a covered expatriate, they are subject to tax on the net unrealized gain as if they had sold such property on the day before expatriation. There are certain exceptions for what is referred to as eligible deferred compensation.
4. Planning can avoid or mitigate exit tax consequences. Getting up to date on past tax compliance can avoid covered expatriate status. Gifting of appreciated assets can decrease one’s net worth to below the net worth threshold or at least minimize the potential gain. Timing is important on the gifting.
5. Gifting after expatriation is subject to a special 40% gift/estate tax on U.S. recipients receiving gifts or inheritances from covered expatiates. Unlike the normal estate and gift tax rules this tax is imposed on the recipient rather than the donor/estate.

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