By Vincenzo Villamena, CPA
In the last decade, the number of US citizens renouncing their citizenship has increased drastically. Fears surrounding high taxes and an increasingly complicated filing system has left many US citizens concerned. The situation is particularly difficult for US persons who spend the majority of their time outside of the United States or who no longer live there.
Extensive tax returns, complex filing requirements, and difficulty when banking compound the issue. For many people, their solution is renunciation.
Video: What are the Implications of Renouncing US Citizenship?
Implications of giving up US citizenship
Though renunciation has become increasingly popular, it is a decision that requires significant consideration. When giving up your US citizenship, you are fully surrendering all the rights associated with being an American citizen. This includes the right to vote, your ability to visit and work in the United States, and potential support from the US government in an emergency.
There are many aspects to consider before deciding to renounce. Some of these aspects will be personal, such as your financial circumstances, your long term plans, and the expected taxation in your new country. However, tax issues such as whether you will be considered a “covered expat” and the impact on future gifts and inheritance should be a key factor in this decision.
It’s also important to realize that renouncing US citizenship is not an easy way out of paying taxes. Depending on your specific situation, it could even cost you. If you do decide to renounce your US citizenship, it is important to be aware of these potential ramifications. You need to plan carefully to avoid costly mistakes.
Tax implications of renunciation
A common myth about renunciation is that it means you will be free from the American tax regime. However, the process of renunciation and no longer holding a US passport can create new tax liabilities. These potential new expenses include an exit tax for “covered expats” and increases in inheritance and gift taxes.
The Exit Tax and Covered Expats
The primary tax incurred by individuals who give up their American citizenship is called the exit tax. This tax only applies to individuals who qualify as “covered expats.”
What is a Covered Expat?
You are considered a covered expat if you fit into one or more of the following categories:
- Your average annual US income tax liability over the last five years is greater than $165,000 (2018).
- Your net worth is equal to or greater than $2 million at the time of renunciation, or
- You have not been tax compliant for the last five years.
It is important to note that married couples must each qualify individually.
Exceptions to these rules include dual citizens who were born in another country and individuals who have not lived in the US for more than 10 of the last 15 years. To find out if you qualify, talk to a consultant with renunciation experience.
What is Exit Tax?
You can think of exit tax as the theoretical taxes incurred if you sold your entire estate and financial accounts the day before renunciation. This even applies to assets that cannot be sold. The phantom profits of these deemed sales are then taxed.
You can exclude the first $713,000 (2018, indexed annually for inflation) of deemed capital gains from the tax. The taxes apply only to capital gains of over $713,000. If you qualify as a “covered expat” you pay tax at the highest marginal tax brackets. Some exceptions are made for eligible deferred compensation plans and cash in accounts.
You should also keep in mind that your country of residence may tax profits from these same assets again if, for example, you sell the assets or receive deferred compensation.
Inheritance and gifts
Another critical change after renunciation is increased taxes on inheritances and gifts. A key concern is that US heirs of non-US citizens face higher estate taxes. While US citizens can shield up to $11.2 million (2018) from estate taxes, non-US citizens are only exempt up to $60,000. For this reason, it is crucial to structure your estate properly.
Likewise, gifts from non-US spouses to US spouses are taxed. A gift from a non-US spouse to their US spouse is taxed after only $154,000 (2019). Alternately, between two US spouses, tax-free gifts are unlimited.
Pre-expatriation planning tips
To minimize the tax implications of relinquishing your US citizenship, there are several steps you can take. For example, giving away assets can help you stay below the net worth threshold of $2 million for covered expats. Common ways to do this include moving your assets to a trust and giving assets to a non-US resident alien spouse or next of kin.
US citizens can gift up to $11.2 million tax free (as of 2018) under the lifetime gifting exemption. It may be beneficial to make gifts above this amount to minimize future inheritance taxes depending on your situation.
An additional strategy is to give away appreciated assets to minimize the mark-to-market tax. A covered expatriate may make gifts before expatriation, but it is important to do so carefully and strategically.
How to renounce your US citizenship
6 steps to renounce the American citizenship:
- Obtain a second passport
- Be up to date on your US taxes
- Prepare expatriation paperwork
- Book your appointment
- Attend you renunciation appointment
- File your final US tax return
Let’s review each step in more detail.
1. Obtain a second passport
Even though it is your right to expatriate, if you expatriate without a second passport, you run the risk of becoming stateless if there is a visa issue in your current country of residency. For this reason, you should obtain a second passport before renunciation.
You can typically obtain an additional passport through family, investment programs, or residency programs which lead to citizenship. Popular programs include Nevis, Antigua, Malta, Bulgaria, Granada, Domenica, Spain, Portugal, Panama, Turkey, and more.
2. Be up to date on your US taxes
In order to expatriate and not automatically be considered a covered expat, you need to be up to date on filing the last 5 years of tax returns. If you haven’t filed your US taxes, the Streamlined Procedures can provide some reprieve.
3. Prepare expatriation paperwork
You will need to fill out the form called “Request for Determination of Possible Loss of US Citizenship,” also known as form DS-4079, and attach supporting documents, including a birth certificate or certificate of naturalization from the country of your second passport.
Be aware that the reason for renunciation cannot be taxes. You will need to have a valid reason. For example, a stronger connection to another country, you no longer live in the United States and will not return, or an injustice experienced as an American.
4. Book your appointment
Ideally, book your appointment at the embassy or consulate in the country or city where you plan to live once you renounce your passport. However, if you are not able to, you can also use a consulate in another country or city. We have seen clients save time by going to renounce in a neighboring country as some of the more common countries have waiting lists of over a year (UK, Canada, Singapore, etc).
5. Attend your renunciation appointment
Make sure you bring the following to your renunciation appointment:
- US passport
- Second passport
- Birth certificate or naturalization certificate associated with the second passport
At the end of your appointment, you will receive a Certificate of Loss of Nationality (CLN).
6. File your final US tax return
Your final tax return will be from January 1 through the day that you expatriate. If your renunciation date is any day other than December 31, you will need to file Form 1040 and 1040NR (if applicable) for your final return.
If you are considered a covered expat, you will need to calculate your exit tax on IRS Form 8854. Failure to file this form means you are still liable for U.S. income tax indefinitely – even if you have completed renunciation for immigration purposes.
If you had foreign accounts already in existence before expatriation, you will also need to file FinCEN Form 114 also known as the FBAR.
Keep in mind that if you still have income in the US, including pensions or rental properties, you must still file annual tax returns.
Eligibility for pension, social security and military pension after renunciation
After expatriating, you are still eligible to receive social security if you previously qualified by having enough credits. You can also still receive your 401k and pension, albeit both are subject to US taxes. You may have to file the 1040NR return unless there is an automatic withholding.
Military pensions however are revoked when one expatriates as the person can no longer be called into active military service as a non-citizen.
Penalties for not filing the expatriation form
You must file your IRS Form 8854 when you expatriate. If you do not, you could be subject to a significant fine from the IRS. As of 2019, the fine for failure to submit this form and its instructions is $10,000. The IRS takes this issue seriously and will send notices to expatriates who have not complied. Likewise, the IRS applies the penalty of $10,000 as appropriate.
In some specific situations, the new Relief Procedures for Certain Former Citizens (Expat Relief) may eliminate the taxes, interest, penalties and exit taxes incurred when relinquishing citizenship. It is difficult to qualify for the Expat Relief.
Navigating the complexity of renunciation
The process of renunciation is a complex one with a high risk of mistakes and potential unintended consequences. Without careful planning, you can be exposed to substantial taxation.
Before giving up US citizenship, consulting a tax professional is highly advisable. At Online Taxman we have guided many clients through the process of renunciation and can advise you on the exact strategies you need to make the process successful. Book a renunciation consultation with our expert here: