U.S. EXIT TAX

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December 3, 2019
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U.S. EXIT TAX

This article provides general guidance (and is not legal advice) on the United States expatriation tax (aka “exit tax”) as it pertains to U.S. citizens and U.S. green card holders (aka “permanent residents”).      

The U.S. imposes income tax on the worldwide income of its citizens and green card holders even if they reside overseas. U.S. citizens and certain green card holders residing overseas are also subject to U.S. gift and estate tax on transfers of worldwide assets. As a result, such individuals sometimes consider relinquishing their citizenship or green card with the hope of freeing themselves from the U.S. tax system. 

However, giving up U.S. citizenship or a green card on or after June 17, 2008 – the date of enactment of the Heroes Earning Assistance and Relief Tax (HEART) Act, may cause the expatriating individual to be subject to an exit tax and treated as if all assets were sold on the day before the expatriation date. Furthermore, U.S. persons receiving gifts from persons expatriating under the HEART Act may be subject to tax.    

Whether you are subject to the expatriation tax or not, you must file Form 8854 – Initial and Annual Expatriation Information Statement. A $10,000 penalty may be imposed for failure to file Form 8854 when required.  IRS is sending notices to expatriates that have not complied with the Form 8854 requirements, including the imposition of the $10,000 penalty where appropriate.

All U.S. citizens who relinquish or “give up” their citizenship status and “former long-term residents” who give up their green cards after June 17, 2008, are subject to the expatriation rules under the HEART Act, if they meet any of the following three tests:

  1. Net Income Tax Test – For the five-year period before expatriation, the individual had an average annual U.S. income tax liability of at least $168,000 for 2019, adjusted annually.      
  2. Net Worth Test – The individual’s net worth is at least $2 million (any debt must also be taken into consideration).        
  3. Certification Test – The individual fails to certify that he or she satisfied all applicable U.S. tax obligations for the five years before expatriation.

A “former long-term resident” is an individual who has held a green card for any portion of at least eight (8) of the fifteen (15) tax years preceding expatriation.  An individual who has been resident in the U.S. for eight (8) years under any other immigration status, such as a work visa, is not a long-term resident for purposes of the expatriation rules.

A green card holder shall be deemed to have expatriated on the date that lawful permanent resident status ceases. This occurs when:

  1. the individual’s status of having been lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with immigration laws has been revoked or has been administratively or judicially determined to have been abandoned, or
  2. the individual:
    1. commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country,
    2. does not waive the benefits of the treaty applicable to residents of the foreign country, and
    3. notifies the IRS of such treatment on Forms 8833 and 8854.

The expatriation rules under the HEART Act contain two key components: a deemed sale of all assets as of the day before expatriation, and a tax on the receipt of gifts or bequests by a U.S. person from an individual who expatriated on or after the date of enactment of the rules.  There are marital and charitable deductions available for transfers to a U.S. citizen spouse or a qualified charity.

Deemed Sale

An individual will be deemed to have sold all assets on the day before the date of expatriation for fair market value. Losses may be taken into account, but only to the extent of gains; therefore, application of the expatriation rules may not result in a loss for tax purposes. The first $600,000 of net gain is excluded for each expatriating individual; this $600,000 amount will be indexed annually.  For 2014, the exclusion amount is $680,000. As discussed below, this exclusion is not applicable with respect to certain deferred compensation assets, certain interests in foreign trusts, and specified tax-deferred accounts. A basis adjustment will be applied to all property subject to the deemed sale provisions; such adjustment will ensure that an actual sale at a future date would not result in double taxation due to the prior application of the deemed sale rules. 

Tax on Gifts and Bequests

A U.S. person who receives a gift or bequest from a covered expatriate is subject to U.S. tax on the receipt of such gift. The total value of the gift is first reduced by the available annual exclusion ($15,000 in 2020), and tax is then assessed at the highest applicable gift tax rate at the time of the gift (in 2020, the top gift tax rate is 40 percent).  

Special Rules – deferred compensation assets, tax-deferred accounts & trust interests

In general, deferred compensation includes all types of employer retirement plans including foreign plans, qualified retirement plans, and nonqualified retirement plans. In addition, it includes property transfers or the right to future property transfers that an individual is entitled to receive in connection with the performance of services to the extent that amounts have not been previously included in taxable income. Tax-deferred accounts include individual retirement plans, qualified tuition plans, Coverdell education plans, health savings accounts, and Archer MSAs.

Paying the Expatriation Tax

A covered expatriate may elect to defer the tax resulting from the application of the deemed sale rules (but not the special rules for deferred compensation, tax-deferred accounts, or non-grantor trusts) until the later of: 

  1. The due date of the tax return for the year in which a particular asset for which the deferral election was made is actually sold or otherwise disposed of.
  2. The due date of the individual’s final income tax return in the case where the covered expatriate dies owning property for which the deferral election was made. 

Interest is charged during the period the election is in place with respect to the deferred gain, and security must be posted as collateral. 

The deferral election may be made for all assets subject to the deemed sale rules or only for certain select assets. The election to defer tax under the HEART Act expatriation rules may compromise the ability of a covered expatriate to take certain treaty positions. Note that the deferral election is not applicable with respect to deferred compensation, specified tax accounts, and foreign trust rules. 

The HEART Act contains two very limited exceptions to the expatriation rules. In order to be exempt from the expatriation rules, an individual must meet one of the following requirements: 

  1. Dual-Citizen Exception: An individual will meet this exception if the following three factors are met: 
    1. The individual was born with dual citizenship (i.e., U.S. and some other country). 
    2. The individual retains his or her non-U.S. citizenship and is taxed as a resident of such other country.
    3. The individual has been a resident of the U.S. for no more than 10 taxable years during the 15 taxable years prior to (and including) the expatriation year. 
  2. Exception for Certain Minors: An individual will meet this exception if: the individual relinquishes U.S. citizenship before reaching age 18., and the individual was not a U.S. resident for more than 10 years preceding expatriation. 

Conclusion

Relinquishing your U.S. citizenship or green card is a complex tax matter. Therefore, it is important that any Canadian planning to relinquishing your U.S. citizenship or green card contact an experienced cross border tax & immigration lawyer. If you have any questions regarding this or any other cross border legal issue, please contact Michael Kennedy at 519-252-3888 or mk@ingenuitycounsel.com.      

Legal Disclaimer: The information contained herein is for informational purposes only and cannot be relied upon as legal advice.  Every person’s needs and situation are different that must be analyzed independently.  After reading this article, if you feel you have, or a client has, U.S. tax exposure or any other U.S. tax or legal issue, you should promptly consult with an experienced U.S. lawyer in order to examine the situation. Your reliance upon any information contained in this article will not create an attorney-client relationship with the author.      

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