Is it Time to Bid Adieu to U.S. Citizenship? Do I Still Pay Taxes

Is it Time to Bid Adieu to U.S. Citizenship? Do I Still Pay Taxes

Time to Bid Adieu to U.S. Citizenship?

Each year, thousands of U.S. Citizens and Long-Term Lawful Permanent Residents (LTRs) decide to renounce their U.S. citizenship or terminate their long-term lawful permanent residence status. Technically, this is referred to as expatriation. The process of expatriating from the United States can be a very complex undertaking, depending on whether the taxpayer is considered a covered expatriate or not when they leave the United States. That is because if the expatriate is not deemed a covered expatriate when they exit, they are not subject to an exit tax at the time they leave. However, when the taxpayer is considered a covered expatriate, they may have to pay an exit tax at the time they file their final U.S. person tax return — although not all covered expatriates are subject to U.S. exit tax. And while the most common type of exit is the tax paid on unrealized gains, there are other categories of exit tax as well — such as ineligible deferred compensation and specified tax-deferred accounts. Let’s work through what happens when Taxpayers give up their citizenship.

Timing Your Renunciation is Important: Taxes Before Immigration

One very important component of renouncing U.S. citizenship is to ensure that the taxpayer gets the timing correct. Typically, that means waiting to conduct the immigration component of immigration (renouncement) until the taxpayer has their ducks in a row regarding taxation (IRS).  In other words, taxpayers want to be careful before renouncing their U.S. citizenship because even if they are below the net worth test or the net income average tax liability test, if they are not tax compliant for the past five years (which is a common scenario for Accidental Americans), they may be considered a covered expatriate and become subject to exit tax — wherein if they had submitted an offshore disclosure before expatriation that outcome could have been avoided.

Does the Taxpayer Have a Second Citizenship?

Another very important component for taxpayers who are renouncing their U.S. citizenship is that they are required to have a second citizenship before the U.S. government will approve the renouncement. For taxpayers who are dual citizens, this is not an issue. However, for taxpayers who may be considering renouncing their U.S. citizenship solely for offshore tax purposes, it is very important to know that they must have second citizenship first. In addition, taxpayers must be wary of all the glossy offshore marketing materials they will find when researching foreign citizenships — because many ‘citizenship-by-investment’ opportunities have hidden fees and tax implications that companies selling these citizenships fail to tell the taxpayer until it is too late to go back.

Are you Anticipating Being Covered Expatriate?

The biggest issue with renouncing citizenship from a tax perspective is whether the taxpayer will be considered a covered expatriate at the time they renounced their citizenship. Reiterating what was stated above, if the taxpayer is not a covered expatriate, they will not be subject to exit tax. Noting, there is a potential issue involving PFIC taxes — even for non-covered expatriates. If the taxpayer is considered a covered expatriate, then they may be subject to exit tax if they meet any (not all) of the three covered expatriate tests. Golding & Golding has other expatriation tax resources available that provide more detail regarding the covered expatriate tests).

• • • Test 1 Net-Worth: if the taxpayer has a net worth of more than $2,000,000 then they may be considered a covered expatriate.

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    • Test 2 Tax Liability: if the taxpayer has a net average income tax liability over the past five years that exceeds $201,000 (2024 Tax Year) then they may be considered a covered expatriate. This value adjusts for inflation whereas the net worth threshold historically has not adjusted for inflation.

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    • Test 3 Tax Compliance (5-Years): if at the time of expatriation, the taxpayer cannot show under penalty of perjury that they are five years tax compliant they will be considered a covered expatriate — even if they fail tests 1 and 2.

If Taxpayers are Not Covered  

If Taxpayers are not covered, then you do not have any exit tax implications.

If Taxpayers are Not Covered  

If Taxpayers are covered, then they may have an exit tax implication, but not always.

‘Sometimes’ Tax Planning Can Help

Sometimes tax planning can help taxpayers avoid becoming covered expatriates, but this comes with various caveats. First, beware of any potential sketchy trusts that purport to protect your assets before expatriation. Typically, these will not work because trusts still have an exit tax implication. When it comes to giving gifts to reduce net worth, there is a three-year pullback for most gifts (certain exceptions for spousal gifts) — but if the spouse is ultimately planning on expatriating as well this may not be much of a benefit and accomplishing little more than just kicking the can down the road (especially if the exit tax rules change). Finally, while tax planning is a great mechanism to try to avoid covered expatriate status, sometimes timing and ‘life events’ make it impossible for the taxpayer to plan a perfect exit from the U.S. This is especially true in situations where they want to expatriate because they may have an upcoming event that may result in a windfall they do not want to be a U.S. person at that time — noting that ‘tax reasons’ is not an approved reason for renouncing citizenship. Thus, it is important to look at the totality of the circumstance when deciding how much or how little tax planning may benefit the taxpayer at the time of exit.

Ready for the Immigration Component

Once a person has properly put their tax plan into place, then they may consider going in to renounce their U.S. citizenship. For citizens, this is typically done overseas at a consulate/embassy. Depending on which country the taxpayer wants to go to renounce their citizenship, there may be very long lines and waiting before they get the opportunity to renounce. Some consulates are stricter than others and may require the taxpayer to have a cooling-off period and multiple trips to the consulate before they approve the Taxpayer’s paperwork. In addition, taxpayers should also be prepared to complete the necessary Department of State forms 4079 through 4083.

Final Tax Return Filing

Presuming that the taxpayer does not intend on becoming a U.S. person for tax purposes again in the future then they will have one more tax filing, to file their final tax return– which would be a dual-status return depending on what day of the year they renounced their U.S. citizenship — and they will also be required to file a form 8854. Some taxpayers who maintain a 401K or other U.S. investments may be required to file an annual 8854 form. Since most taxpayers who are expatriating do not want this additional headache, they may want to sell off certain U.S. assets before exiting — which although may bring an immediate tax implication, may provide overall peace of mind of knowing they no longer have to file U.S. tax returns, aside from possibly reporting any US sourced income on a form 1040NR.

The Tip of the Iceberg

This article aims to help clarify some of the basics of renouncing U.S. citizenship. Being tax compliant when a person expatriates is very important and exit taxes in general can be very complicated, especially when it involves additional items such as foreign life insurance policies, foreign corporations, foreign partnerships, and transactions between U.S. persons and foreign companies. Taxpayers should try to stay in compliance if they are already in compliance or should consider getting into compliance if they have not properly filed the necessary reporting forms if for no other reason than the fact that the IRS has made offshore compliance a key enforcement priority and has been issuing fines and penalties for non-compliance. 

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.