The Expatriation Tax (Part Two)
You are not subjected to the exit tax rules simply because you are a citizen or a long-term resident. You must do something to trigger the application of the exit tax: terminate your citizenship or long-term resident status.
U.S. citizens can choose to give up citizenship, or have it taken away from them. Losing citizenship makes a (former) U.S. citizen an expatriate under the exit tax rules. Most people relinquish U.S. citizenship by renunciation. The process is straightforward: sign some documents, answer some questions, pay a fee, and make an oath in front of a U.S. consular official to voluntarily renounce your U.S. citizenship. Citizenship can be lost by methods other than formal renunciation. In a few instances, the government can take U.S. citizenship away from you. When the process is complete, the State Department issues a Certificate of Loss of Nationality to confirm that you are no longer a U.S. citizen.
Green card holders are also affected by the exit tax rules. A green card holder must have been a lawful permanent resident in eight of the 15 years ending with the year of expatriation—in other words, the green card holder is a long-term resident (a defined term in the IRC). Only green card holders who are long-term residents are affected by the exit tax rules.
Once long-term resident status is attained, there are two ways that a green card holder can trigger the exit tax rules. First, the green card holder can voluntarily abandon the visa status or the government might forcibly cancel the visa. This event causes the long-term resident to be an expatriate, subject to the exit tax rules. Visa status is voluntarily abandoned by filing Form I-407 with the USCIS.
Long-Term Residents Make a Treaty Election Second, the long-term resident might trigger the exit tax rules by making a treaty election to be a nonresident, thereby ceasing to be a lawful permanent resident. The green card holder makes this election by filing a Form 1040NR for the year in question, with the treaty election on an attached Form 8833. The election, if made after the green card holder becomes a long-term resident, will cause the individual to be an expatriate.
Are You a Covered Expatriate or Not?
Once you have determined that you have expatriated (given up citizenship for citizens, abandoned visa status, or elected nonresident tax status for long-term residents), the next task is to figure out the consequences of that event. The exit tax rules will create two possible income tax consequences for citizens and long-term residents who expatriate: paperwork only or paperwork plus tax.
Covered expatriates face the prospect of paperwork plus tax liability, while noncovered expatriates bear the paperwork burden only. U.S. persons who receive gifts or bequests from covered expatriates also suffer: They pay a tax when receiving a wealth transfer from a covered expatriate.
“Covered expatriate” is a term of art, defined in the IRC. It means someone who is an expatriate (a citizen who has relinquished citizenship, or a long-term resident who has given up green card visa status or has made a treaty election to be a nonresident) and has failed (or satisfied, depending on your point of view) one of three tests.
The three tests are designed to identify people who are rich (in the eyes of the IRC) or noncompliant with U.S. tax law. They are covered expatriates.
Expatriates who are fully tax-compliant and of modest means (from the IRC’s point of view) are not covered expatriates. The IRC does not give these people a name, but for clarity’s sake they are informally referred to as “noncovered expatriates”.
The first way to become a covered expatriate is to have net worth of $2,000,000 or more on the date of expatriation. The amount is not indexed for inflation. This is called the net worth test.
The second way to become a covered expatriate is to have a high enough average net income tax liability for the five tax years before the year of expatriation. The threshold amount for expatriations in 2019 is $168,000, and it is indexed for inflation. This is the net tax liability test.
The final way to become a covered expatriate is to be noncompliant with tax obligations for the five tax years before the expatriation year. Full compliance with Title 26 (the entire IRC) is required. You must certify full compliance under penalty of perjury, and—if audited—prove it. This is the certification test.
There are two categories of expatriates for whom the net worth test and the net tax liability test will not apply:
- Dual citizens of acquired U.S. citizenship and another citizenship at birth; and
- People who expatriate before age 18 1/2.
For those who qualify for one of the exceptions, personal wealth and prior years’ income tax liability will not cause the individuals to be covered expatriates. However, the taxpayers will still be required to satisfy the certification test, and failure to do so will make them covered expatriates.
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