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Trimming US Expatriation Fee Wouldn’t Simplify Tax Compliance

11/17/2023

(This article was originally published in Bloomberg Tax by Jimmy Sexton. Link to the article here.) 

More expatriations are expected if the Department of State’s proposal plays out to reduce the fee to end US resident status for federal tax purposes to $450 from $2,350. This is, of course, if the department follows through.

Since the Foreign Account Tax Compliance Act law in 2010, many have expatriated to rid themselves of their US tax obligations. The previously free act came with a $450 fee starting in 2010 and rose to $2,350 in 2014 due to a 360-fold increase in people wanting to expatriate.

FATCA requires foreign financial institutions to send information about US account holders’ accounts to the IRS. Prior to FATCA, most US citizens living abroad weren’t tax compliant because they didn’t realize they had to pay US tax on their foreign income or file US tax returns and information returns, such as the Report of Foreign Bank Financial Accounts. Furthermore, US tax laws largely weren’t enforced against US citizens living abroad because the IRS had no information about them.

With FATCA, the IRS would receive US citizens’ bank account information, including balances. They could easily compare this information with individuals’ tax and FBAR records to see if they were compliant.

Expatriating without getting proper tax advice is problematic because individuals can only get rid of future US tax obligations, not past obligations. Former US citizens are still liable for their US tax obligations for when they were citizens.

Those who expatriate and aren’t tax compliant for the five years prior to expatriation are classified as covered expatriates and are subject to an exit tax system and other punitive tax measures.

A covered expatriate is someone with a net worth of at least $2 million who either has average annual income tax more than $190,000 (2023 amount, indexed for inflation annually) over the five years prior to expatriation, or who isn’t in tax compliance for the five years prior to expatriation. Everyone else is a non-covered expatriate.

There’s no exception to the tax compliance test. Not being tax compliant equals covered expatriate status—it’s that simple.

The exit tax covered expatriates are subject to is a mark-to-market tax on unrealized gains, subject to a $821,000 gain exclusion (indexed for inflation annually). Additionally, most deferred compensation items, such as retirement accounts, are treated as distributed on the day before expatriation and subject to tax. These items don’t qualify for the gain exclusion benefit. Finally, any US person who receives a gift or inheritance from a covered expatriate will be subject to gift or estate tax at the highest rate then in effect, currently 40%.

Getting tax compliant for purposes of expatriation means ensuring your tax returns for the five years prior to expatriation are filed, and that all unpaid tax, penalties, and interest is paid. There have typically been two ways of going about this: a quiet disclosure or taking part in an IRS amnesty program.

A quiet disclosure is basically filing tax returns and paying any tax, penalties, and interest for the five years prior to expatriation and hoping for the best. Because it isn’t an authorized IRS amnesty program, there’s no penalty protection; the IRS is free to audit the returns and assess penalties to the maximum allowed by law. Most people prefer an official IRS amnesty program in which penalties are limited.

Depending on the person’s circumstances and when they were getting back into compliance, this means taking part in the Offshore Voluntary Disclosure Initiative, Offshore Voluntary Disclosure Program, or one of the streamlined procedures (filing five years of past tax returns rather than the three required).

The IRS announced relief procedures in 2019 to help those who expatriated and weren’t tax compliant, or who are planning to expatriate and aren’t tax compliant, to be classified as non-covered expatriates rather than covered expatriates. To qualify, the expatriate must have a net worth of less than $2 million and an aggregate tax liability of $25,000 or less for the taxable year of expatriation and the five prior years.

Those who qualify must file a dual-status return and Form 8854 for the year of expatriation, as well as tax returns for the preceding five years, but they don’t have to obtain a Social Security Number. They will also have to submit other documents, such their Certificate of Loss of Nationality and ID. The relief procedures are a big help to ordinary US citizens living abroad who want to expatriate.

They’re also helpful for accidental Americans—those US citizens who have little or nothing to do with the US but who are US citizens because they happened to be born in the US or to a US parent abroad. Most accidental Americans don’t have SSNs, which are required for a quiet disclosure or to take part in an IRS amnesty program, and obtaining one can be a long, tedious, and frustrating process.

Those who don’t qualify for the relief procedures will need to obtain an SSN (if they don’t have one) and get back in compliance by doing a quiet disclosure or taking advantage of an IRS amnesty program.

Tax laws on expatriation are complicated, and getting expert advice prior to expatriation is key to reducing the tax consequences. If the expatriation fee is reduced, more people will be able to afford to expatriate.

But how is someone who can’t afford $2,350 to expatriate going to afford a competent expatriation tax adviser, even with a lower expatriation fee? The IRS should consider making more resources available or setting up workshops for lower-income expatriates.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jimmy Sexton advises private clients on international tax and wealth planning. He is founder and CEO of Esquire Group and chairman of the International Business Structuring Association (Middle East Chapter).