Abandoning US Citizenship or Green Card? Here is Something You Should Know

If you are a U.S. citizen or a permanent U.S. resident, you are taxed on your worldwide income. It does not matter where you live, where the income is earned, or where else you might pay tax. Many US citizens and Green Card holders are finding themselves in a situation where they are working abroad US but paying tax on their global income in the US. You may claim foreign earned income exclusion and foreign tax credits on your U.S. tax return. But you have to file your tax return and claim those exclusion and credits on your return. Someone then is to weight the options and consider renouncing the U.S. citizenship or Green Card. This move was primarily to save on taxes and reduce burden of filing tax return and information disclosure forms.

If you are among the many that have renounced or are considering renouncing their U.S. citizenship or Green Card, there are some things you must consider from the tax perspective.

1. Officially Relinquish US citizenship or permanent residency 

Leaving the United States with the intention of never returning is insufficient to relinquish citizenship or terminate residency. For persons who are US citizens, the expatriation day is the earliest of the following four events:

  • renunciation ofUSnationality before a diplomatic or consulate officer;
  • furnishing the US State Department with a signed statement of voluntary relinquishment ofUSnationality;
  • issuance by the US State Department of a certificate of loss ofUSnationality; or
  • cancellation of a certificate of naturalization by aUS Court.

U.S. permanent resident status is terminated for purposes of the expatriation tax on the earliest date of the following actions taking place:

  • Voluntarily filing Form I-407, Abandonment of Lawful Permanent Resident Status, to Homeland Security, or
  • A final administrative order of removal from the U. S. the Immigration and Nationality Act, or
  • Commence to be treated as a resident of a foreign country under the tie-breaker provision of a U. S. income tax treaty, does not waive the benefits of the treaty applicable to residents of the foreign country, and notifies the IRS of such treatment on Forms 8833 and 8854.

2. File form 8854

In either case of losing citizenship, or in the case of losing permanent residency, you must file a IRS Form 8854, Initial and Annual Expatriation Statement.  Until you file this form, you will continue to be treated as if you were still aUScitizen or green card holder for tax purpose.

Filing Form 8854 itself does not give rise to any tax liability. It is just a form to communicate change of your tax status.  Form 8854 includes information on your new country of tax residence, the date of your expatriation from the US, your US tax liability in the last 5 years and the fair market value of all properties and investments you held as of the date of your expatriation, to certify their compliance with their U.S. tax obligations for the prior five years.  Failure to file Form 8854 where required may result in a penalty of $10,000 for that year unless it is shown that such failure is due to reasonable clause and not willful neglect.

3. Special Tax Rule for Long-term Residents

The U.S. expatriation tax provisions apply to U.S. citizens who relinquish their citizenship and long-term residents who surrender their green card. A long-term resident is a non-U.S. citizen who is a lawful permanent resident of the U.S. in at least 8 years during the 15-year period before that person’s residency ends. A “lawful permanent resident” means a green card holder, which does not include the resident alien for income tax purpose based on the substantial presence test.  In applying the 8-of-15-year test, it should be noted that holding a green card for as little as one day in a particular year causes that year to be counted for purposes of this test.  Therefore, an individual who holds a green card for as little as 6 years and a few days could satisfy the 8 year requirement and thus, be subject to the expatriation provisions.

However, in determining if an individual has satisfied the 8 year holding requirement to be subject to the expatriation provisions, it is possible to exclude the time an individual was treated as a resident of a foreign country under tie-breaker provision of a tax treaty, provided the individual has not already met the 8-of-15-year test.

4. “Covered Expatriates” is Subject to Expatriation Tax

An individual who gives up U.S. citizenship or terminates green card status after meeting the 8-of-15-year test described above will be a “covered expatriate”, and therefore subject to expatriation tax rules if he or she meets any of the following tests:

  • The average annual net income tax liability for the five preceding years ending before the date of relinquishment of U.S. citizenship, or termination of permanent residency exceeds $155,000 (for 2013; this amount is adjusted annually for inflation);
  • The net worth of the individual is $2 million or more on the date of expatriation (this amount is not adjusted for inflation); or
  • The individual fails to certify compliance with all U.S. federal tax obligations for the preceding five years, or fails to submit such evidence of compliance as the U.S. Internal Revenue Service may require.

5. Exceptions of “Covered Expatriates”

There are two exceptions that may exclude a U.S. citizen from otherwise qualifying as a covered expatriate: if the expatriate is a person born as a citizen of both the U.S. and another country, who continues to be a citizen of, and is a tax resident of, that other country as of expatriation, and has either been (i) a U.S. resident for not more than ten out of fifteen of the taxable years immediately preceding expatriation, or (ii) a person who relinquished U.S. citizenship before reaching age eighteen and a half, provided he or she had been a U.S. resident for no more than ten taxable years before such relinquishment.10 Note that there are no similar exceptions for long term residents.

6. Exit tax for “covered expatriates”

Covered expatriates who expatriate after June 16, 2008, will find themselves immediately subject to a mark-to-market tax on their world wide assets that requires the expatriate to recognize gain as if those assets were sold for their fair market value as of the day prior to expatriation. If a property was acquired before the expatriate’s U.S. citizenship or permanent residence, the expatriate’s basis in that property, for purposes of this tax, will be the fair market value of that property at the time the expatriate became subject to U.S. federal tax laws as a permanent resident.

There is some relief to the mark-to-market tax since the covered expatriate may exclude the first $600,000 of gain (which is indexed for inflation so that the excluded amount for 2009 is $626,000, and $627,000 for 201021). Actual subsequent gains and losses realized are then adjusted for gains and losses recognized under the market-to-market tax, without including the $600,000 exclusion.

There are three groups of assets that will not be subject to the mark-to-market tax but are subject to other taxes upon expatriation or upon receipt:

  • deferred compensation items,
  • specified tax deferred accounts, and
  • any interest in a non-grantor trust.

If a covered expatriate has one or more of these types of accounts or interests the day before expatriation, IRS Form W-8CE must be filed with each payor of any of these items within 30 days of expatriation. This form effectively notifies the payor of such account or interest that the covered expatriate is subject to these special tax rules.

The covered expatriate may also choose to make an irrevocable election on any or all property to defer the recognition of gain but will be required to post adequate security, pay interest on the deferred tax, and irrevocably waive any benefit under a U.S. tax treaty with respect to such tax assessment.24 In addition, to make such an election, the covered expatriate must enter a tax-deferral agreement with the IRS which includes, among other things, appointment of a U.S. agent. If such an election is made to defer the mark-to-market tax, the deferred tax must be paid once the property is actually disposed of.

Amounts held by covered expatriates in tax deferred accounts such as certain individual retirement plans, qualified tuition program, Coverdell education savings accounts, health savings accounts and Archer medical savings accounts will be treated as if the funds were distributed on the day before relinquishment but not subject to early distribution penalties.

Any gain or loss from the deemed sale under the mark-to-market rule is calculated on Form 8854, then transferred to the appropriate line or schedule of Form 1040, U.S. Individual Income Tax Return, depending on the type of income.  After applying the exclusion amount pro-rata to the items that give rise to gain, the covered expatriate is required to pay expatriation taxes along with regular income tax by the tax return due date.  The character of each gain or loss remains the same; thus long-term capital gain would be taxed at the preferential tax rate, and short-term gain or deferred compensations are taxed as ordinary income at graduated tax rates, along with all other income normally reported on the individual income tax return.

7. covered gifts and covered bequests

In addition to the new mark-to-market tax under § 877A, § 2801 provides new succession tax rules to replace the previous special transfer tax rules for covered expatriates. Under § 2801, a transfer is subject to a succession tax if it is a “covered gift” or a “covered bequest”. A covered gift is a gift received directly or indirectly by aU.S.person from a donor who at the time the gift is made is a covered expatriate.  Similarly, a

covered bequest is a bequest received directly or indirectly by aU.S.donee from the estate of a covered expatriate. The covered gift or bequest is subject to the highest estate or gift tax rate available which means possibly higher transfer tax rates may be imposed than if the transfer was made by aU.S.donor. Although theU.S.donee is liable for the tax imposed under § 2801, such donee may exclude the first $13,000 of gifts or

bequests received from covered expatriates in the aggregate in each year.44 Thus, the donee can only exclude the first $13,000 of covered gifts and bequests received in that year regardless of the number of covered expatriate donors involved. Both donor and donee seem to lose out on these new succession tax rules. First, the donor’s opportunity to reduce his or her estate by gifting is diminished because the donee pays the tax. In turn, the donee receives a significantly lower net value in the gift because he or she carries the burden of paying the gift or estate tax due post transfer.

8. What Happens to My Pension/Retirement Plan When I Expatriate?

pension payments from qualified retirement plans. Most such payments are treated as distributions from an ERISA-qualified retirement plan. This includes 401(K) plans and most state and federal pension plans. Simple IRAs and SEP IRAs are treated the same as a qualified plan.

If you’re a “covered expatriate,” there’s a 30% withholding tax on distributions from a qualified plan that would have been taxable had you remained a U.S. citizen or resident. There’s a second 30% withholding tax imposed when funds are transferred to the country you live in after expatriation. Covered expatriates can’t use a tax treaty to reduce this second withholding tax.

If you’re not a “covered expatriate,” you’re only subject to a single 30% withholding tax when the pension payments are sent to another country. You may be able to use a tax treaty to reduce this tax.

Individual Retirement Accounts. If you’re a covered expatriate, your IRA terminates when you expatriate and you must pay tax on the entire untaxed portion of the plan. A small consolation: If you’re under 59 1/2, the early distribution penalty does not apply. If you’re not a covered expatriate, the plan does not automatically terminate, but a withholding tax of up to 30% applies to cross-border distributions.  This tax may be reduced under a tax treaty.

9. What Happens to My Social Security Benefits and Medicare When I Expatriate?

Social security benefits–There are no restrictions on Social Security payments sent abroad unless you live in a country upon which the U.S. government has imposed trade or financial restrictions; e.g., Cuba, North Korea, or Iran.

If you’re not a U.S. citizen, depending on where you live, there may be a withholding tax of as much as 30% on the first 85% of your monthly payment. This percentage may be reduced or eliminated if there’s a tax treaty between the U. S. your residence country.

Medicare You don’t need to be a U.S. citizen to enroll in Medicare. However, Medicare services are available only in the United States. Unless you have a passport from a visa waiver country, you need a visa to visit theUnited States. That’s generally not difficult to obtain, but unless you live in a nearby country, it’s not a very practical strategy.

10. Should I file Annual Form 8854?

IRS Form 8854 is called the Initial and Annual Expatriation Statement. You must file initial Form 8854 to establish your expatriation for tax purposes (for the initial year of expatriation). You must also file annual Form 8854 to make an annual statement in compliance with information reporting requirements if you expatriated after June 3, 2004 and are under Internal Revenue Code section 877 or section 877A.

If you are a covered expatriate you may have elected to defer payment of tax on the gain from any of your deemed property sales until the year you actually sell the property.  If you made such a deferral election on your initial Form 8854 then you have to file Form 8854 annually each year up to and including the year of the sale.
If you are a covered expatriate and had eligible deferred compensation or an interest in a non-grantor trust when you expatriated you have to file Form 8854 each year and indicate whether or not you received any distributions from the deferred compensation plan or trust that year.  You can expect the payor of these distributions to withhold 30% tax.

11. Does Expatriating End Your U.S. Tax Obligations?

Generally, an expatriate with no connection to the U.S. subsequent to expatriation should have no subsequentU.S.tax obligations. But expatriates may continue to have otherU.S.tax obligations, including:

  • Filing Form 1040NR to report and pay tax on any U.S. source income that was not paid through withholding, as well as anyU.S.effectively connected income (such as deferred compensation payments). A nonresident alien not engaged in a U.S. trade or business is not required to file a U.S. tax return if the U.S. tax liability is satisfied through withholding, pursuant to Regulations Section 1.6012-1(b)(2).
  • ReplacingU.S.withholding certificates (such as replacing the Form W-9, filed with brokers, investment advisers, etc., with Form W-8 BEN). Failure to do so may lead to underwithholding ofU.S.tax, such as onU.S.source dividends, requiring the expatriate to file aU.S.tax return and pay any deficiency.
  • Form W-8CE should be filed with the payor of any deferred compensation item, such as an IRA custodian, 401(k) administrator or obligor of any other form of deferred compensation.

12. Tax Classification of Expatriates Returning to US for Visits

Expatriate who leaves the United States ceases to be a U.S. resident for tax purposes.  That person no longer needs to pay income tax in the United States, and that person is no longer subjected to the U.S. tax reporting forms such as the FBAR and FATCA.
If you give up you U.S. permanent resident visa and later return to the United States for a visit, you will be considered a U.S. resident for tax purposes if you meet the substantial presence test for the calendar year—expatriates and covered expatriates, regardless of expiration date. To meet this test, you must be physically present in the United States on at least:

  • 31 days during the current year, and
  • 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:
    • All the days you were present in the current year, and
    • 1/3 of the days you were present in the first year before the current year, and
    • 1/6 of the days you were present in the second year before the current year.

The 30 days restrictive rules apply only to “covered expatriates” who expatriated before June 18, 2008. If you are in the United States for more than 30 days in a calendar year, you will be treated as a U.S. resident for all tax purposes.  You must file Form 1040 (the resident’s income tax return).  You must satisfy all relevant reporting requirements (Form TD F 90-22.1, etc.).  If you make a gift in that calendar year you may have to pay gift tax.  If you die during that year, all of your worldwide assets are subjected to U.S. estate tax. If you are a mere “expatriate” you are free to enter the United States as a tourist, without suffering ill effects under the U.S. tax regime.
If your expatriation date is June 18, 2008 or later, you are exempt from the “more than 30 days makes you a U.S. resident for tax purposes” rule.  This applies to expatriates as well as covered expatriates.