Expatriation, the act of renouncing one’s citizenship or giving up long-term residency, has become increasingly common among U.S. citizens and green card holders. However, this process is governed by complex rules and significant tax implications, especially for those classified as “covered expatriates.” Understanding these classifications, rules, penalties, and consequences is crucial for anyone considering expatriation.
Covered Expatriates
“Covered expatriate” is a term the U.S. applies to individuals who meet at least one of the following criteria:
- Net Worth Test: A personal net worth of at least $2,000,000 USD (excluding spouse’s net worth)
- Tax Liability Test: An average net tax liability of at least $201,000 over the past five years (indexed for 2024), which considers joint tax liability for joint returns
- Certification Test: Failure to certify compliance with U.S. tax obligations for the past five years
Special Obligations for Covered Expatriates
Covered expatriates must follow several rules or penalties, including:
- Form 8854: Filing this form in the year of expatriation is required by law.
- Deemed Disposition of Assets: All property is considered sold at fair market value (FMV) the day before expatriation, with gains above an exemption threshold subject to tax. For 2024, the exemption threshold is $866,000 USD.
- Deferred Compensation Plans: Depending on whether they are eligible or non-eligible, deferred compensation plans are subject to various tax implications, including 30% withholding on distributions and potential deemed distributions.
Detailed Consequences
Deemed Disposition: All property owned by the expatriate is treated as sold at FMV the day before expatriation. The first $866,000 USD of gains (as of 2024) is exempt, with taxes applied proportionally across all assets. This tax can be deferred with the posting of security, although interest will still be charged.
Deferred Compensation Plans
- Eligible Plans: Subject to 30% withholding tax on distributions, without the benefit of foreign tax credits for reducing withholding
- Non-Eligible Plans: Deemed to have been received in full at present value on the expatriation date, with immediate taxation and potential foreign tax credits
IRAs and Non-Grantor Trusts: IRAs and 529 plans are treated as if their entire value was distributed the day before expatriation, avoiding the 10% early withdrawal penalty. Non-grantor trusts face a 30% withholding on distributions.
Gift and Inheritance Taxes: Gifts and inheritances from covered expatriates to U.S. citizens, residents, or U.S. trusts are subject to a 40% tax, akin to an inheritance tax but with no exemptions or credits. This is not reduced by foreign tax credits, making it particularly relevant for Canadian citizens due to the absence of Canadian gift or estate taxes.
Conclusion
Expatriation from the U.S. entails significant financial and tax considerations, especially for covered expatriates. The penalties can be severe, including deemed disposition taxes, withholding on deferred compensation, and hefty taxes on gifts and inheritances. Anyone considering expatriation should seek professional advice to navigate these complexities and ensure compliance with U.S. tax obligations.
By understanding the rules, penalties, and consequences, individuals can make informed decisions about expatriation and its impact on their financial future.