Giving Up Your Green Card or U.S. Passport May Result in A Tax Bill
There may be valid economic reasons for an individual to want to expatriate from the US. The US imposes tax on US citizens and US residents on their worldwide income and imposes the burden of having to file annual complex informational tax returns. For individuals who are living abroad or seeking to spend only a few years in the US after obtaining their green card, expatriation may be an attractive option to avoid the US tax system. However, if the individual plans on spending more than a small amount of time in the US after they expatriate then expatriation is generally not favorable. Additionally, an individual considering abandoning their US citizenship (or long term permanent resident status) should consider whether they will be earning US source income and whether they will be making gifts to US people or forming US trusts, after their expatriation date.
Gifts made by expatriated persons to US persons are subject to US tax (essentially an inheritance tax payable by the US person receiving the gift or bequest), even though the expatriated person is no longer subject to US estate tax on their worldwide assets; instead the expatriated individual is subject to US estate tax only on their US situs assets (the same as noncitizens non domiciliaries of the US). Additionally, transfers (both during life and at death) to a U.S. trust by a “covered expatriate” (a term defined later in this article) are subject to tax immediately. The trust is responsible for paying the tax. However, transfers to a foreign trust by a covered expatriate are only taxed at the time a U.S. beneficiary receives a distribution from the foreign trust. When the tax applies, the U.S. beneficiary is responsible for paying it. However, the U.S. beneficiary is entitled to a deduction, under IRC §164, for the tax attributable to the portion of the distribution also included in his or her gross income.
Note that the inheritance tax will not apply to gifts and bequests made by a covered expatriate during any period following expatriation when the expatriate is again subject to tax as a US citizen or US resident.
The expatriation tax (hereafter “exit tax”) is a mark-to-market tax whereby a deemed sale occurs and the individual is forced to recognize gain on the difference between the fair market value and cost basis of their assets. The exit tax only applies to (1) U.S. citizens who have renounced their citizenship and (2) long-term residents who have ended their residency. An individual is considered a “long-term resident” for U.S. federal income tax purposes if they were a lawful permanent resident of the United States (green card holder) in at least 8 of the last 15 tax years ending with the year their residency ends. Therefore, unless the individuals are US citizens or are considered “long-term permanent residents” they should not be subject to the exit tax if they later abandon their citizenship or green card status.
Additionally, in order to be subject to the exit tax the individual must be considered a “covered expatriate” under IRC §877A. The definition of a covered expatriate is an individual who: (1) has an average annual net income tax liability for the 5 preceding tax years of more than $165,000 (for 2018) [use the amount filed on the joint income tax return for both husband and wife]; (2) has a net worth of $2M or more; or (3) fails to certify, under penalties of perjury, compliance with all US Federal tax obligations for the 5 taxable years preceding the expatriation date [Form 8854].
There is, however, a special exception for individuals, who at their birth, are dual citizens of the US and another country and have not spent significant time in the US in 10 of the past 15 years. Specifically, dual citizens, who meet the physical presence test for less than 10 years of the last 15 years are not subject to the exit tax.
Fortunately, even when an expatriating individual is subject to the exit tax, the US provides a threshold level of gain that must be reached before an expatriating individual would be subject to the US exit tax. The threshold level is periodically adjusted for inflation. For the 2018 year, the expatriating individual can expect to exclude up to $711,000 of gain at the time of expatriation.
This results in fewer individuals actually having to pay the exit tax. As should be evident from the foregoing, a complicated set of rules apply once an individual decides they would like to leave the US tax system. Analysis should be done before hastily abandoning your US citizenship or green card.