Tax compliance has become increasingly complex due to expanded overseas bank and financial account reporting and tax compliance requirements. There has been a rise in the number of the estimated six million US citizens living abroad who are giving up their US citizenship. According to the US Treasury Department, a record 3,415 Americans renounced their citizenship in 2014. The rise continues as in the first quarter of 2015 alone, according to recent data released by the IRS, more Americans living outside the US gave up their citizenship than ever before. According to data compiled by Bloomberg, the 1,335 expatriations in the first quarter of 2015 surpassed the previous record by 18 percent.
The question becomes, is there a correlation between the increasingly complex tax compliance requirements and the increase in the number of US citizens giving up their citizenship? While there can be non-tax related factors which can influence one’s decision to relinquish US citizenship or lawful US permanent residency (US green card), from a tax practitioner’s point of view, there is likely a correlation. The daunting task of filing tax returns with the added burden of reporting overseas bank and other financial account information can be a challenging experience for US citizens, US green card holders and US tax residents.
If you are considering giving up your US citizenship or green card, what do you need to know from a US income tax perspective?
First, you need to know whether you will be subject to the “Expatriation Tax”. It is very important to carefully consider the potential effect of the Expatriation Tax that may result from the decision to renounce one’s citizenship or relinquish one’s US green card. There also can be complex US federal tax filing obligations whether or not the Expatriation Tax applies.
The rules regarding the Expatriation Tax have been in existence since June 16, 2008. Individuals may become subject to Expatriation Tax, also referred to as “anti-expatriation rules,” if:
- US citizenship is relinquished; or
- US permanent residency is relinquished by a “long-term US resident,” meaning someone who has been a lawful permanent resident of the United States in at least 8 of the last 15 years.
And, if any of the following three tests are satisfied:
- Tax Liability Test: The individual’s average annual net federal income tax for the 5 years preceding the year of expatriation exceeds $160,000* (* indexed annually for inflation).
- Net Worth Test: The individuals’ net worth exceeds $2,000,000 upon expatriation.
- Certification and Compliance: The individual fails to certify under penalty of perjury that he or she has met the requirements of the Internal Revenue Code for the 5 preceding years, or fails to submit evidence of such compliance.
An individual who satisfies this test is then considered a “covered individual,” and the resulting Expatriation Tax is generally calculated by treating the individual’s assets as having been sold on the date of expatriation. The resulting tax may result in a hardship for the individual. Since their assets have not actually been sold, they may not have enough available funds to pay the tax related to the deemed sale of the assets.
Additionally, the Expatriation Tax is reported on specified forms which differ from the usual income tax return. Therefore, the individual should be prepared for the administrative task of preparing such a filing, including gathering records regarding the fair market value of investment holdings and for the possibility of needing to engage a professional to assist with preparation of the return.
What are the possible planning considerations and filing requirements?
One way for a green card holder to avoid falling subject to the Expatriation Tax is to track their lawful permanent residency period. If they can legally relinquish the green card before the 8 year period has lapsed, it may be possible to avoid the Expatriation Tax, and its related burdens, altogether. Note that a partial year will count as a full year for this test.
If the individual is not able to relinquish their green card before the 8 year period, they may still escape the grasp of the expatriation tax if none of the other tests are satisfied. The individual will need to file the appropriate form to show they did not meet these additional tests.
The individual will still need to prepare and file the appropriate income tax return in the final year of residency. Depending upon what date the green card is relinquished, there are different filing positions that could be applied to the return, including preparing the return as a “dual-status” return or as a full year resident return. Each filing position presents differing advantages and disadvantages. Thus, it may be necessary to prepare estimates of the resultant tax liability for both positions for comparison.
There may also be treaty positions to examine and declare in attachments to the return. While the individual may have successfully avoided the Expatriation Tax, the income tax return in the year that one’s green card is relinquished may be substantially more complicated than before. A robust understanding of the underlying Internal Revenue Code and Regulations is a necessity in order to arrive at the most tax-efficient filing position for the income tax return. Thus, the individual may want to budget, not only for the fees for requisite legal and immigration expertise that may be necessary in order to properly relinquish their citizenship or permanent residency, but also for the fees for engaging the services of a knowledgeable tax return practitioner with specific expertise in this area of practice.
What are other Considerations?
Going forward, it is important to remember that the tax return prepared during the year of expatriation may not be the final US tax filing. US-source income that may arise in subsequent years will still need to be evaluated to determine whether a non-resident US income tax return is necessary. A common area where this may arise occurs when an individual has equity income realized in future years, but was earned, at least in part, due to their US work days from previous years. The same is true for US state tax filings related to the US-source income in question; therefore non-resident state tax return filings may be necessary as well.
Additionally, the individual may need to keep more careful records of their income and investment transactions, especially in the year that their US citizenship or green card is relinquished. For example, a US financial institution normally issues tax forms each year which carefully report investment income which is incorporated into the US tax return filing, usually on a Form 1099. However, when the individual informs the financial institution about the change in their legal residency status, the US tax reporting information that will be issued by the financial institution will likely be much more limited and may not include all of the information the needs to be reported on the tax return. This is especially true for dual-status or resident tax return positions. The individual should be prepared to handle the additional administrative burden of record-keeping in such situations.
In the end, while it is difficult to outline the many possible scenarios and comment on all of the tax rules that may apply in the year that one’s US citizenship or green card is relinquished, the need to have an overall awareness of the tax rules and to exercise diligence in planning for such an event remains the same.
If you have any questions please contact Mandy Zeman at +1 (650) 331-0118 or firstname.lastname@example.org.
The information provided is for general guidance only, and should not be utilized in lieu of obtaining professional advice.
Author: Mandy Zeman, Manager
Mandy is a Manager in GTN’s Pacific region and has been with GTN since 2013. She has over 20 years of experience in expatriate US income tax consulting and compliance, including tax equalization, cost projection, and related expatriate and program planning. Mandy has an in-depth knowledge of complex mobility tax issues, extensive experience with the unique tax withholding and reporting challenges facing companies with global equity plans, and provides thoughtful, tailored solutions to each client. +1.650.331.0118 | email@example.com