Expatriation Myths Busted
I am going to be busting some common expatriation myths in this post. If you are reading this post, you most likely know that giving up your U.S. citizenship is referred to as “expatriation”. There are several reasons people expatriate; their new country of citizenship doesn’t allow dual-citizenship, they don’t want to deal with the U.S. tax system, they have conflicting political views, or some other reason.
Making an Informed Decision
Expatriation is not something to be taken lightly, it is irreversible and can have unintended consequences if not properly planned. Making an informed decision whether or not expatriate is key; you need to fully understand the rules governing expatriation, and their impact on your situation. Without that, you are flying blind. And, as a pilot, I can assure you flying blind is not a good idea.
A recent meeting with a prospective client reminded me how many people misunderstand expatriation due to false or outdated information. You’d be surprised how many people base their expatriation decision on information they got a cocktail party, found on the internet, or got from someone who has no clue what they are talking about.
I will have to pay U.S. taxes for 10 years after I expatriate
False. This was the law before June 17, 2008, and only applied to expatriates meeting certain criteria. If you expatriated on or after June 17, 2008, this rule does not apply.
I won’t be able to spend more than 30 days per year in the U.S. after I expatriate
False. Again, this was the law before June 17, 2008. If you expatriated on or after June 17, 2008, this rule does not apply.
Expatriating will solve my past U.S. tax issues by expatriating
False. Expatriation doesn’t make tax noncompliance that occurred while you were a U.S. citizen go away; you are still liable. In fact, expatriating while not being tax compliant automatically makes you a “covered expatriate”, which sucks. I will address “covered expatriate” status at the end of this post.
I will have to pay an exit tax
Maybe. Only “covered expatriates” are subject to exit tax, and there is a gain exclusion amount that applies. I will address “covered expatriate” status at the end of this post.
I will lose my social security
False. You get to keep your social security, although it will likely be subject to U.S. withholding tax.
Expatriate vs. Covered Expatriate
If you give up your U.S. citizenship, you are an “expatriate”. If you are unlucky enough to meet certain criteria, you will be a “covered expatriate”. Meeting any one of the following criteria will make you a covered expatriate:
- You have a net worth of $2M or more;
- You have an average annual income tax liability of $165K (2018 amount) for the 5 years prior to expatriation; or
- You fail to certify, under penalty of perjury, on Form 8854 that you were tax compliant for the 5 years prior to expatriation.
If you are an expatriate–meaning not a covered expatriate–you can more or less expatriate without any tax consequences.
If you are a covered expatriate, however, you aren’t quite so lucky. Covered expatriates are subject to an exit tax. The exit tax is mark-to-market tax on the unrealized gains of your worldwide assets; basically, it is as if you sold everything you own for fair market value the day before you expatriate. You do, however, receive a gain exclusion of $713K, so in reality, you only actually pay the exit tax on gains above that amount. In addition, you generally have to pay tax on any deferred compensation items (e.g. IRAs, annuities, etc…) as if they were paid out on the day before you expatriate. Hold tight, the fun isn’t over yet. As a covered expatriate, if you give any gifts or leave any inheritance to U.S. persons, the U.S. recipients will have to pay 40% gift or estate tax on the amount received.
The Good News
Now for some good news. If you are planning on expatriating, and would be classified as a covered expatriate, there are pre-expatriation planning techniques that can often move you from being a covered expatriate to being just an expatriate.
Bottom line. If you’re going to expatriate, make sure you are tax compliant for the 5 years prior to doing so, and get some good advice.
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