US Expatriation Tax

Expatriation tax is imposed on individuals who renounce their U.S. citizenship and certain long-term U.S. residents who terminate their residency status.  This tax regime was introduced in 1966 and has been subsequently amended many times.  The most current version of this tax regime is outlined in the Heroes Earnings Assistance and Relief Act (HEART) of June 17, 2008.

As renouncing citizenship became a popular way for U.S. citizens to avoid tax, HEART came into effect to address concerns about people abusing the system.  Originally, expatriation tax was levied on certain post-expatriation income.  With HEART, the government now imposes a general exit tax on the gain of the taxpayer’s world wide assets.

Affected individuals

U.S. Expatriation tax can apply for U.S. citizens and Long-term U.S. residents. A long term U.S. resident is an individual who was lawful permanent resident (green card holder) at any time in any of the 8 taxable years during the 15 year period preceding termination.

The two steps required for an individual to be considered to have expatriated for tax purposes are different for U.S. citizens and long-term residents.

1. If you are a U.S. citizen, you must give notice of an expatriating act to the Secretary of State. Then you should notify the IRS of your intention to expatriation by filling Form 8854 (“Initial and Annual Expatriation Statement”).

2. If you are a long-term resident, you must give a notice of termination of residency to Secretary of Homeland Security. Then you should notify the IRS of your intention to expatriation by filling Form 8854.

Expatriation date

If you expatriated on or after June 17, 2008, the HEART expatriation tax rules will apply to you if any of these criteria apply:

1. If you are a US citizen, you shall be treated as relinquishing your citizenship on the earliest of the following dates when:

a. You renounce nationality before a diplomatic or consular officer of the U.S.

b. You furnish a signed statement of voluntary relinquishment to the U.S. Department of State

c. The U.S. Department of State issues to the individual a certificate of loss of nationality

d A U.S. court cancels a naturalized citizen’s certificate of nationalization, provided that renunciation or relinquishment under (1) or (2) above is subsequently approved by the issuance to the individual of a certificate of loss of nationality by the U.S. Department of State.

2. If you are a green card holder, you shall be treated as expatriation on the date when:

A. A  green card is determined to have been revoked or judicially or administratively abandoned

B. A long-term resident invokes a tax treaty to be treated as a resident of a foreign country and does not waive the benefits offered by the treaty to residents of such foreign country.

Note: If you expatriated before June 17, 2008, you should follow the U.S. Expatriation Tax rules under AJCA. Please contact your accountants for details.

Exceptions:

There are two exceptions for dual citizens and minors:

Dual citizen exception: an individual will meet this exception if the following three factors are met:

The individual was born with dual citizenship (i.e. U.S. and some other country)

,p>The individual retains his or her non- U.S. citizenship and is taxed as a resident of such other country

The individual has been a resident of the U.S. for no more than 10 taxable years during the 15 taxable years prior to the expatriation year.

Exception for Certain Minors: An individual will meet this exception if the individual relinquishes U.S. citizenship before reaching age 18.5 and the individual was not a U.S. resident for more than 10 years preceding expatriation.

Alternative Regime of Taxation:

As U.S. citizens could renounce citizenships to avoid tax, alternative Regime of taxation is introduced.

For the 10 years following the date of expatriation, the affected individuals are:

-Subject to U.S. tax on gains on U.S. situs assets such as shares and bonds of U.S. corporations.

-Subject to U.S. tax on U.S. source investment income

-Not able to claim principal residence exemption

-Required to file Form 8854 for each of the 10 years

Note: The alternative tax regime will not apply for the year in which the individuals are in the U.S. for more than 30 days. The individuals will be treated as a U.S. resident in that year in which the individual needs to report the world income for tax purposes.

Special Reporting Requirements:

The affected individuals should notify the IRS of their intentions to expatriation by filling Form 8854 (“Initial and Annual Expatriation Statement”).

In addition, the affected individuals must file Form 8854 for the next 10 years following expatriation in order to satisfy the annual reporting requirement under the expatriation tax<p>ation rules. If Form 8854 is not filed in a timely manner or not filed properly, a $10,000 penalty may be imposed.

Case Study

Here is the breakdown of his assets:

Cash: $1,000,000

Personal Home in the U.S.: $1,000,000

Stock Portfolio: $1,000,000,

John has $500,000 in his Individual Retirement Account and wants to know if he should withdraw the entire amount or keep some in the account. He also received US dividends on June 1, 2014. He has $100,000 in employment income for the month of January. Jane has no assets and has not had to pay taxes in the last 10 years. What will John and Jane’s tax consequences look like?

Tax Consequences

Since John has had his green card for over 8 years before he expatriated, John will be considered a long term resident for tax purposes. On the date that John decides to expatriate, his total net worth is over $2 million, thus, he will be subject to expatriation tax rules under HEART. First, John will have to file Form 8854 to give his initial expatriation statement to as well as his expatriation tax return for 2014.

On the expatriation return, the amount that he has withdrawn out of his Individual Retirement Account will be included in income along with his employment income. He will also include any capital gains as a result of deemed dispositions of his home and stock portfolio at fair market value. However, since his dividend income was received after the date of expatriation, it will be considered non-resident income and will be subject to withholding taxes. Jane will be considered a citizen until she notifies the Secretary of State of her intention to expatriate and files Form 8854. However, given her situation, she will not be subject to expatriation tax as she does not meet any of the criteria. Her net worth is not more than $2 million, she had no tax liability, and has met all tax obligations for the past 5 years.

ABOUT THE AUTHOR

ALLAN MADAN

CPA, CA

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

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