The Expatriation Tax (Part One)
Are you a green card holder planning to go back to your home country? Are you a U.S. citizen planning to retire in a foreign country? These actions trigger a tax problem: the expatriation tax (a.k.a. the exit tax).
The exit tax rules impose an income tax on someone who has made his or her exit from the U.S. tax system. The defining feature is that assets are treated as if they are sold on the day before citizenship or resident status is terminated.
Net capital gain (after an exemption) from the deemed sale is taxed immediately. There are other rules that accelerate income for a person leaving the United States. These rules apply to things like IRAs, pensions, deferred compensation plans, and beneficial interests in trusts.
The United States is not alone in having an exit tax, but it is unique in tying its exit tax to a change in visa or citizenship status. This is called “citizenship-based taxation.” If you are a U.S. citizen or resident alien, you are taxed on worldwide income. Every other country (except Eritrea and a few other limited case exceptions) follows a residence-based taxation system. If you are a resident (however defined) of that country, you are taxed. If you are a nonresident (however defined), you are not taxed. This is why it is easy for Canada, which has residence-based taxation, to allow its citizens to live abroad and be taxed as nonresidents, while it is impossible for the United States, which has citizenship-based taxation, to do so.
The citizenship-based tax principles in the DNA of the IRC are the reason that giving up citizenship or residence is a tax recognition event—and the reason that the exit tax rules exist.
The exit tax applies to two categories of people:
- U.S. citizens who terminate their citizenship
- long-term residents—lawful permanent residents of the United States (holders of a “green card” visa)—who terminate that status after holding it for many years
If you do not fall into one of those two categories, you do not need to worry further about the exit tax rules. Thus, for instance, someone living for decades in the United States under other visas (student, H-1B, L-1A, etc.) will never have a concern about paying exit tax.
Citizens of the United States trigger the exit tax rules when they voluntarily or involuntarily terminate that status. By giving up citizenship, they become expatriates under the IRC. It is usually simple to determine your U.S. citizenship. If you are born in the United States, you are a U.S. citizen. It is sometimes a bit complex to determine whether someone born outside the United States (with U.S. citizen parents) is a citizen or not. A naturalized citizen will have a vivid memory—and some paperwork—to prove acquisition of U.S. citizenship. People will almost always know whether they are citizens of the United States or not.
Dual citizenship does not matter. Acquiring citizenship of a second country will not terminate U.S. citizenship, unless you successfully persuade the State Department that your acquisition of citizenship in another country is a relinquishment of your U.S. citizenship.
People who are not citizens of the United States can also be subjected to the exit tax. They must be long-term residents of the United States.
- Resident status means that they are lawful permanent residents of the United States: green card holders.
- Long-term means that they have held lawful permanent resident status—even for a split-second of time—in at least eight out of the last 15 years. In making this “eight out of 15” calculation, there are special rules for disregarding years in which these people lived abroad and filed U.S. income tax returns claiming nonresident status under the terms of an applicable income tax treaty.
This communication is not intended to be tax advice and should not be treated as such. Readers should contact your tax professional to discuss your specific situation.
Oscar Eduardo Mary is a founding member of RCBM, an international tax and business consulting firm headquartered in Buenos Aires, Argentina and with a branch office in Carrollton, Texas. RCBM assists companies that want to operate in Argentina and / or United States. You may contact him at email@example.com