Every year, a significant number of American citizens and green card holders eschew the rights associated with those privileges, giving them up entirely. The reasons for expatriation, as the renunciation of one’s citizenship or giving up of one’s green card is commonly called, vary, but often center on tax considerations.
Many who wish to avoid the United States’s policy of worldwide taxation of income, and who have legal status in another country, take this step for financial reasons. But if you’re thinking about making this leap, you should know that cutting ties with the United States might not relieve you entirely of your U.S. tax obligations.
Note that rules affecting this tax differ depending on when you expatriated; this article addresses only expatriation occurring after June 16, 2008.
The expatriation tax refers to the obligation of “covered expatriates” (explained below) to pay taxes on unrealized gains related to their entire estate upon giving up their U.S. citizenship or green card. Some call it a punitive measure -- the jealous lover taking one last swipe at the one lost -- but it can also be rationalized as the U.S. government making sure it gets what it otherwise would have eventually gotten (through continued taxes or eventually through the estate tax) had the taxpayer not opted for (supposedly) greener pastures. The gains were realized in the United States, so the thinking goes, so U.S. taxes should be paid on them.
In addition to possibly having to pay the actual expatriation tax, you’ll need to certify to the IRS when you give up your citizenship or green card, on Form 8854, Initial and Annual Expatriation Statement, that you’re squared away on your U.S. taxes for the last five years. This requirement applies to anyone who expatriates, and not just those who get hit with the expatriation tax. Failure to file this form can, in certain cases, lead to a fine of $10,000.
As noted, “covered expatriates” may be subject to the expatriate tax. You’re a covered expatriate if you:
Some exceptions are made for expatriated dual citizens and minors under certain circumstances.
The IRS counts as taxable income for covered expatriates “the net unrealized gain (or loss) in your property as if the property had been sold for its fair market value on the day before your expatriation date.” In other words, the IRS will act as if you've sold all your belongings -- wherever they are in the world -- on the day before you expatriate, and will tax at the capital gains rate any profit that this hypothetical sale would have made you (had it actually happened), based on your property’s market value the day before your expatriation.
You don’t get the benefit, in figuring the expatriation tax, of any the tax breaks the tax code would afford you under normal (non-expatriation) circumstances. For example, normally if you sold your house you could exclude up to $250,000 (per person; $500,000 for a couple) for income tax purposes -- but this deduction doesn't exist in determining the expatriation tax.
But there’s an exclusion for expatriation tax purposes up to a certain amount, which changes depending on when you expatriated. A person who expatriated in 2014, for example, wouldn’t owe the expatriation tax on the first $680,000 of “gains” attributed to him or her through the hypothetical sale discussed above. If the hypothetical sale of all your stuff “yields” less than a $680,000 profit, therefore, you wouldn’t owe anything for the expatriation tax.
Accordingly, the expatriation tax ultimately works to the detriment of only the financially well off.
Also, the following assets are exempt altogether from this tax: tax-deferred accounts, some deferred compensation items, certain deferred compensation items, and interests in non-grantor trusts.