As an expatriate, US citizen, or a permanent US resident from abroad, you may face a steep exit tax if you give up your US citizenship or residency at a later date. Fortunately, there are ways to mitigate this tax if you plan ahead, so it’s wise for all expatriates in the US to learn the basics of the expatriation tax as early as possible.
Who Is Subject to the Expatriation Tax?
Like most US tax-related issues, the answer is complicated, so we’re breaking it down into two parts.
First, you must have been a permanent resident (that is, a US citizen or person with a “green card”) for at least eight of the preceding 15 tax years. (Keep in mind that you may hit this limit before spending eight full years in the US if you filed tax returns for years when you only spent a few months stateside.)
- Net-Tax Liability Test: Having an average net annual income tax liability of $171,000 (in 2020) for the preceding five tax years. (This is not your individual taxable income, but the tax liability on that income.)
- Net-Worth Test: Having a net worth of $2 million or more, including all worldwide assets. (For married taxpayers, each spouse’s net worth is calculated separately, so a married couple could have a total net worth of up to $4 million if they owned their assets relatively equally.)
- Certification Test: You fail to certify that you have properly filed all tax returns and tax compliance for the last five years (such as FBARs), and paid all relevant liabilities, interest, and penalties.
The sooner you begin planning, the better you’ll be able to prepare.
How Does the Expatriation Tax Work?
If you are a Covered Expatriate, the IRS will calculate your liability as if you disposed of all worldwide assets the day before the expatriation date, as determined by standard mark-to-market rules. The first $737,000 (in 2020) of net gain is excluded (if married, each spouse may exclude this amount), and the excess is taxed at the applicable rate.
So depending on the individual assets (for example, a house, a retirement account, deferred compensation), the expatriation tax might be some combination of short-term gains, long-term gains, withholdings, etc., and would be taxed accordingly.
No matter what, you would not be taxed a second time on income or capital gains for which you already paid US taxes. Rather, the IRS wants to take this last opportunity to levy taxes on the appreciation of your assets during the time you held permanent residency and/or US citizenship.
When Is the Expatriation Tax Applicable?
A person becomes a Covered Expatriate on the date when one of these situations arises:
- You renounce your US nationality or have it canceled by the State Department or a US court.
- You relinquish your status as a permanent US resident or have it administratively or judicially revoked, or you become a resident of a foreign country in a tax treaty with the United States.
Can You Avoid the Expatriation Tax?
This is where advanced planning is crucial. Knowing the factors that trigger the tax, you might want to consider:
- Keeping net-average income below the threshold
- Transferring assets to a US citizen spouse
- Relinquishing your residency before the eight-tax-year mark
While advanced planning can help you mitigate or avoid this exit tax, if you find yourself having to pay it, you may be able to defer until certain assets are sold (though you will have to satisfy various treaty waiver, security, and other requirements). You may also have some leeway in determining which date counts as the basis for valuing your assets.
A licensed tax advisor and financial planner can help develop the best strategy for your situation, and the sooner you begin planning, the better you’ll be able to prepare. That way, if it ever comes time to leave the US, the last memory of your American home will be a lively farewell party, not an unexpected tax bill.
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