By: Jerald David August
Chair, International Taxation and Wealth Planning Group
Introduction of Set of Expatriation Blog Posts
This is the first in a series of blog posts on the US income and wealth tax implications of expatriation. This post sets forth an introduction into the minefield of tax and non-tax considerations for an individual to consider, with the advice of US and foreign legal and tax counsel, on the merits and drawbacks of expatriation. Unfortunately, the expatriation rules in the Internal Revenue Code also apply to “long-term residents” of the United States, i.e., those who have “resided” in the U.S. for the least the last 8 of 15 years.
Increase in Number of U.S. Citizens and Long-term Residents Expatriating
There is an increasing number of U.S. taxpayers who expatriate each year. Some former U.S. citizens or long-term residents want to permanently reside in another country to avoid the high taxes on income during life and wealth taxes during life and at death.1 In many cases, U.S. expatriates are U.S. citizens or long-term residents who have lived abroad for several years and have decided that they do not intend to live in the United States again, do not believe U.S. citizenship or a green card confers any special benefits to them, and have in good faith completed all U.S. income and informational tax return reporting, while also complying with the tax laws of the country where they reside.
Often, the tax benefit of expatriating has little or nothing to do with reducing the individual’s U.S. tax liability or overall amount of tax paid. Instead, it is driven by a desire to reduce the cost of compliance and prevent the assessment of potential penalties related not to the underpayment of tax but to inadvertent omissions of some information reporting. Consider, for example, a U.S. citizen living in France who owns a greater than 50% interest in 20 CFCs under Code Sec. 951 and now with respect to Code Sec. 951A pertaining to the accelerated “GILTI” income. Such individual also owns several foreign grantor trusts which he established for his children. He files his tax return in France as well in the United States reporting both on a worldwide basis. To meet his U.S. filing obligations, he annually files a U.S. federal income tax return reporting his worldwide income taxable in the United States and his U.S. tax liability, an amount typically offset by foreign tax credits and other allowable deductions, exemptions, and credits. Consequently, he pays no incremental U.S. tax; however, to meet his U.S. filing obligations, There would be significant penalties for this gentleman, if he did not file Forms 5471 for each CFC ($10,000 per year for each CFC with possible additional penalties) and Forms 3520 and 3520A for foreign trusts.
Calls for Increased Income, Estate and a New Annual Wealth Tax
With the divide among our Congressional leadership and calls for much higher income and wealth taxes on the wealthy by members of the House of Representatives from the Democrat party, there is renewed concern about the direction that the United States is taking and that high net worth individuals may find their tax situation must be improved by relinquishing their U.S. citizenship and moving abroad or make their already obtained residence in a foreign country permanent.
The same motivation to exit and return back to a prior country will continue to be under consideration by a long-term resident in returning to his country of citizenship or perhaps to permanently reside in a third country.2 The Heroes Earnings Assistance and Relief Tax Act of 2008 (“HEART Act”) made profound changes in the tax law with respect to the expatriation of U.S. citizens but also with respect to the departure of a long-term resident alien from the United States.3 The HEART Act, which applies to individuals who renounce their U.S. citizenship or relinquish their “long-term resident” status in the United States after June 16, 2018 (at times collectively referred to herein as a “covered expatriate”).
Understanding the Main Rules for Expatriation Under the Internal Revenue Code: The Mark-to-Market Income Tax; The Certification Test; and the U.S. Inheritance Tax Imposed on Donative Gifts from Expatriates
There are two core provisions that are at the center of the HEART Act. First, Code Sec. 877A, which imposes, in general, an income tax on the worldwide assets of the “covered expatriate” as of the day prior to the date of expatriation. There are certain special rules permitting deferral of the special “mark-to-market” tax under Code Sec. 877A subject to an election to accelerate and report the tax in the current year.
There are also important compliance issues involved in expatriation and that concern is sourced from the five-year certification standard whereby the covered expatriate, as part of the departure filings, must certify that he or she has been tax compliant in the United States for the preceding five-year period ending on the last day of the taxable year preceding the year of the expatriation and continuing through the departure year as well.
There is an added or third consequence, i.e., a substantial inheritance tax on U.S. donees of donative transfers received from U.S. expatriates under Code Sec. 2801. Income Taxation of U.S. Citizens and Residents A U.S. citizen, in general, is subject to U.S. individual income tax on his or her worldwide income subject to the allowance of applicable foreign tax credits and other deductions, exclusions from gross income and other allowances. Every person born or naturalized in the United States and subject to its jurisdiction is a citizen. A foreigner who has filed his declaration of intention of becoming a citizen but who has not yet been admitted to citizenship by a final order of a naturalization court is still treated as an alien..The determination of who is a U.S. citizen and when such citizenship has been abandoned is determined by the Immigration and Nationality Act, 8 USC §1401, et seq. .
Well, the above summary is just that a “summary”. More to follow but I will try not to get into the “weeds” too much but its hard to avoid them especially the “big hanging weeds” that can cause economic and legal havoc to the unsuspecting individual who mistakenly believes that expatriation simply involves the filing of a form with the IRS, renouncing his or her U.S. citizenship and getting on a airplane to a new home or perhaps an existing residence in another country.
This post is intended solely for informational purposes and may not be relied upon as legal advice of Fox Rothschild LLP or Jerald David August. If you have any questions on this area of the tax law please call your Fox Rothschild LLP lawyer or Mr. August.