US Insights

Although the idea of no longer being subject to US tax may sound like a way to simplify your affairs, careful consideration should be given to potential exit tax charges once going down the irrevocable route of expatriation.

Exit tax for Covered Expatriates

Covered Expatriates (defined below) may have to pay an ‘exit tax charge’ in order to give up their US status. This is a Capital Gains Tax calculated on the deemed sale of worldwide assets (valued on the day before the expatriation). Although the first $866,000 of the deemed gains are not taxed, the exit tax charge may lead to cash-flow issues as no cash proceeds are received.

Who is a Covered Expatriate?

Before expatriation, US Citizens or individuals who have held a Green Card for at least seven out of the last 15 years (known as long term permanent residents), should determine if they are a ‘covered’ or ‘non-covered’ expatriate.

A US citizen or long-term permanent resident is a covered expatriate if any of the three tests below are met:

1. Average annual net US income tax liability for the five years preceding the year of expatriation exceeds $201,000
2. Worldwide net worth (including home) on the day of expatriation equals $2 million or more
3. Unable to certify via Form 8854 that US tax filings (including foreign reporting forms and FACTA requirements such as Foreign Bank Account Reports) have been fully satisfied for the five proceeding years.

It should be noted that special rules apply to deferred compensation (e.g., company stock options), specified tax-deferred accounts (e.g., IRA, 401K, 529 plans) and interests in non-grantor trusts, meaning covered expatriates may not realise they have breached the $2m worldwide asset test before expatriating.

Non-covered expatriates are not subject to the exit tax and can expatriate free of charge.

Covered Expatriate: The Exceptions

A covered expatriate is not subject to the exit tax charge if they are a dual national from birth, continue to be a citizen of their second country and are taxed as a resident of that country.

Alternatively, US citizens who are under the age of 18 ½ or over the age of 18 ½ but have not been US tax resident for more than 10 taxable years can relinquish their citizenship tax free.

Planning Opportunities

Careful planning before expatriating may reduce (or eliminate) the exit tax charge for covered expatriates. For example, gifting of assets to individuals/charitable organisations can reduce a covered expatriate’s worldwide net worth to under $2m, meaning they are no longer subject to the exit tax charge. However, individuals will need to consider if other US or local income or gift tax charges will be triggered when making these gifts.