Definition of Expatriation: What Does it Mean? Tax Treatment

What is Expatriation

What is Expatriation?

Exit Tax Requirements for Covered Expatriates (Citizens & Residents): Expatriation is a very complex undertaking in which the US government requires certain US persons to follow certain procedures in order to formally cut ties with the United States. One of the most common misconceptions about U.S. expatriation and the IRS definition of an expatriate, is that it only involves U.S. Citizens and it is only for wealthy people — but both of the presumptions are incorrect.  Expatriation is the process of relinquishing U.S. status. It includes both U.S. Citizens and Green Card Holders (aka Legal Permanent Residents) who meet the definition of a Long-Term Resident (LTR). The baseline perspective is that formal expatriation rules apply to US Citizens and Lawful Permanent Residents. If a person does not fall into either of those categories, then when they exit the US — they are not considered expatriates for tax purposes.

U.S. Citizens & Permanent Residents

Expatriation is the process of relinquishing a person’s U.S. status. The expatriation rules apply to more than just the wealthy. Even if a person is below the net worth test, if they meet the net income tax liability test and/or cannot certify that they have been U.S. tax compliance for the last 5-years, they will also qualify as a covered expatriate — and may become subject to U.S. exit tax.   The most common example of an Expatriate is when a person is a U.S. citizen, either by birth or naturalization, but with recent changes in tax laws, many more Long-Term Residents are also relinquishing their US status.

U.S. Citizen Example

In the most common example, a person was born a U.S. citizen.

• • • Example: Michael grew up in the U.S., and then began working overseas.

      • He started making significant income in a foreign country with a lower tax rate.

      • Now that Michael is a high-income earner, he has a dilemma. As a U.S. citizen, he is subject to United States’ tax on his worldwide income.

      • In the foreign country Michael lives and calls home, his tax rate is 20%. In the U.S., Michael’s tax rate is 37%. Michael never visits the U.S. aside from work, and has no other ties to the U.S.

As a result, Michael does not want to pay the hefty additional tax to the U.S., and decides he will relinquish his U.S. citizenship.

Green Card Example (Legal Permanent Resident)

This is becoming more of an issue, as the International Tax and Reporting rules continue to become ever increasingly complex.

• • • Example: Ingrid came to the U.S. as an F-1 student, and then H-1B. A few years later, she because a green card holder and has been in the U.S. ever since 2003.

      • Now it is 2020 and Ingrid wants to move back to Peru, but has amassed significant assets.

      • Her children (and grand-children) are grown, and Ingrid wants to enjoy her sunset years in her home country.

      • From a U.S. tax perspective, Ingrid has been a green card holder for just shy of 20 years.

      • If Ingrid wants to relinquish her green card, she must do more than just let her green card expire — she must file a Form I-407 (or pursue other relinquishment options) and submit a Form 8854.

        • Why?

          • Because Ingrid has been a green card holder for at least 8 of the last 15 years. Therefore, she is considered an LTR (Long-Term Resident) and must file a Form 8854.

        • What happens if Ingrid’s Green Card expires?

          • She may no longer be a valid green card holder but that will not eliminate her U.S. tax responsibilities.

Voluntary Abandonment vs. Involuntary Abandonment

In order to remove a person’s U.S. tax status, they must do more than just let the green card expire. Rather, the person must take proactive action. In other words, the green card holder must take an affirmative step in order to remove the taint of U.S. tax responsibility — even after the Green Card expires.

The simplest method is to file Form I-407.

Form I-407

• • • Form I-407, Record of Abandonment of Lawful Permanent Resident Status, is designed to provide a simple procedure to record an individual’s abandonment of status as a lawful permanent resident (LPR) of the United States.

    • Use of Form I-407 also ensures that an individual abandoning his or her LPR status is informed of the right to a hearing before an immigration judge and that the individual has knowingly, willingly, and affirmatively waived that right.

Form I-407 Certification Language

• • • Form I-407, Record of Abandonment of Lawful Permanent Resident Status, is designed to provide a simple procedure to record an individual’s abandonment of status as a lawful permanent resident (LPR) of the United States.

    • Use of Form I-407 also ensures that an individual abandoning his or her LPR status is informed of the right to a hearing before an immigration judge and that the individual has knowingly, willingly, and affirmatively waived that right.

    • Form I-407, Record of Abandonment of Lawful Permanent Resident Status, is designed to provide a simple procedure to record an individual’s abandonment of status as a lawful permanent resident (LPR) of the United States.

    • Use of Form I-407 also ensures that an individual abandoning his or her LPR status is informed of the right to a hearing before an immigration judge and that the individual has knowingly, willingly, and affirmatively waived that right.

Covered Expatriate vs. Non-Covered Expatriate

When it comes to evaluating expatriation, one of the most important determinations is whether or not the person who is expatriating qualifies as a covered expatriate.

To recap the process:

• • • First, the expatriate must determine if they are U.S. Citizen or Long-Term Resident

    • Then, conduct the three different covered expatriate tests.

A. Net Income Tax Liability

Your average annual net income tax liability for the 5 tax years ending before the date of expatriation is more than the amount listed next.

• • • $139,000 for 2008.

    • $145,000 for 2009.

    • $145,000 for 2010.

    • $147,000 for 2011.

    • $151,000 for 2012.

    • $155,000 for 2013.

    • $157,000 for 2014.

    • $160,000 for 2015.

    • $161,000 for 2016.

    • $162,000 for 2017.

    • $165,000 for 2018.

    • $168,000 for 2019.

    • $171,000 for 2020.

    • $172,000 for 2021.

    • $178,000 for 2022.

B. Net Worth Test

Your net worth was $2 million or more on the date of your expatriation.

C. 5-Year Tax Certification

You fail to certify on Form 8854 that you have complied with all federal tax obligations for the 5 tax years preceding the date of your expatriation.

Exceptions

There are a few exceptions to the covered expatriate status. 

As provided by the IRS:

Dual Citizens and Certain Minors

• • • Dual-citizens and certain minors (defined next) won’t be treated as covered expatriates (and therefore won’t be subject to the expatriation tax) solely because one or both of the statements in paragraph (1) or (2) above (under Covered expatriate) applies.

    • However, these individuals will still be treated as covered expatriates unless they file Form 8854 and certify that they have complied with all federal tax obligations for the 5 tax years preceding the date of expatriation as required in paragraph (3) (under Covered expatriate, earlier).

Certain Dual-Citizens

• • • You can qualify for the exception described above if you meet both of the following requirements. 

      • You became at birth a U.S. citizen and a citizen of another country and, as of the expatriation date, you continue to be a citizen of, and are taxed as a resident of, that other country. 

      • You were a resident of the United States for not more than 10 years during the 15-tax-year period ending with the tax year during which the expatriation occurred.

    • For the purpose of determining U.S. residency, use the substantial presence test described in chapter 1 of Pub. 519.

Certain Minors

You can qualify for the exception described above if you meet both of the following requirements.

• • • You expatriated before you were 181/2. 

    • You were a resident of the United States for not more than 10 tax years before the expatriation occurs.

For the purpose of determining U.S. residency, use the substantial presence test described in chapter 1 of Pub. 519.

Expatriation with IRS Offshore Disclosure

A very common situation in the past few years has been when a U.S. Citizen or Long-Term Resident wants to expatriate but is out of international offshore reporting compliance.  In this scenario, the client is unable to certify that they have been tax compliant for five years.

Therefore, we develop a strategy to both get the client into offshore compliance — and complete the expatriation process.

Interested in Expatriation from the U.S.?

Our firm specializes exclusively in international tax.

Contact our firm today for assistance with getting compliant.