Expatriation is the renouncement of a United States (US) citizenship or the termination of a permanent residency. A primary purpose of expatriation is to avoid US taxes. Therefore, the tax code provides an expatriation tax and specific requirements for expatriation. This article summarizes the rules for expatriation on dates after June 17, 2008 — see Publication 519, U.S. Tax Guide for Aliens for the different tax rules that apply to expatriations before that date. The expatriation tax is figured on Form 8854, Initial and Annual Expatriation Statement, which is attached to Form 1040 or Form 1040NR.
For a US citizen, the expatriation date is the earliest of:
- when the taxpayer renounces citizenship before diplomatic or consular officer of the US and that was later confirmed by the issuance of a certificate indicating the loss of nationality
- a signed statement of voluntary relinquishment of US nationality furnished to the State Department that confirms the performance of an expatriate act and also confirmed by the issuance of a certificate of the loss of nationality
- the date that the State Department issued such a certificate
- the date that a US court cancels a certificate of naturalization
Permanent residents will be subject to the expatriation tax if they held their green card for at least 8 out of the 15 years previous to the expatriation date, in which case, they are covered expatriates. A year is counted if the green card was held for at least 1 day during that year. Hence, some permanent residents relinquishing their green cards may be considered a covered expatriate if they held their green card for a little more than 6 years and at least one day before the 6-year period and 1 day afterward.
Expatriates must file Form 8854 even if they do not satisfy the income or net worth tests to at least certify that they have complied with tax obligations for the previous 5 years. Otherwise, a $10,000 penalty may apply unless the failure to file Form 8854 was due to reasonable cause, not willful neglect.
A permanent resident terminates her status on the earliest of:
- filing Form I-407, Abandonment of Lawful Permanent Resident Status with a US consular or immigration officer and confirmed by the Department Of Homeland Security
- when the resident leaves the US because of a final administrative order for his removal under the Immigration and Nationality Act
- when a dual resident chooses to be treated as a resident of another country under a tax treaty between that country and the US, and the resident filed Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b) and Form 8854 with the IRS
Both resident and nonresident aliens are not permitted to leave the United States or any of its possessions without a certificate of compliance from the IRS (sailing or departure permit). The certificate must be obtained, by filing Form 2063, U.S. Departing Alien Income Tax Statement and Annual Certificate of Compliance, at least 2 weeks before leaving the US, which serves as proof that US income taxes have been paid (IRC §6851). The final tax return must still be filed since the certificate does not serve as a return.
The expatriation rules only apply when tax avoidance is a primary reason for the expatriation. Hence, there is a presumption of tax avoidance if any of the following are true. The expatriate:
- has a high net worth of at least $2 million (not adjusted for inflation)
- failed to file Form 8854, asserting that all US federal tax obligations for the preceding 5 years ending before the expatriation date are satisfied
- deferred the payment of tax, received compensation eligible for deferment, or has an interest in a nongrantor trust
- owed a significant amount of income tax for the 5 years ending before the expatriation date
The amount of net income tax liability triggering a presumption of tax avoidance is adjusted annually for inflation. The applicable average amount for the 5 years before the expatriation is determined by the year of expatriation:
So if a taxpayer expatriated in 2017 and owed an average of at least $162,000 in taxes for each year during 2011-2016, which is the most recent 5-year period ending before the date of expatriation, then there will be a presumption of tax avoidance as a reason for the expatriation, and, thus, be subject to the expatriation tax.
Some citizens with dual citizenship and certain minors may be exempt from the above rules. Dual citizens will qualify for the exception if the US citizenship was acquired because of being born in the US while also being a citizen of another country and is taxed as a resident of that country or the taxpayer met the substantial presence test for no more than 10 years during the 15 year period ending before the expatriation date. A minor will be exempted if they were expatriated before reaching 18½ or the minor met the substantial presence test for no more than 10 years before the expatriation.
Calculating the Expatriation Tax
On the day before expatriation, most of the property of the expatriate in the US will be subject to a mark-to-market tax, an income tax on the net unrealized gain or loss in the property, as if the property were sold at its fair market value. Losses from deemed sales are treated under normal tax rules except that the wash sale rules under IRC §1091 do not apply. However, any net gains can be reduced by the following amounts, but not below 0, based on the expatriation date:
The tax can only be deferred if there is little chance that tax collection will be jeopardized. In such a case, the payment of the tax is deferred until the due date of the return for the tax year in which the property was disposed of unless the IRS prescribes another date. If the covered expatriate dies, then the tax must be paid by the due date of the return for the tax year in which the expatriate died.
The mark-to-market tax is determined by multiplying the total mark-to-market tax by the ratio of the gain of the deemed sale of the property over the total gain with respect to all property deemed sold. A covered expatriate must file an information return on Form 8854, Initial and Annual Expatriation Statement for each year when the mark-to-market tax applies. Any property subject to the mark-to-market tax will receive a stepped-up basis which can be used to compute the total gain after an actual sale, by subtracting the deemed sale price. However, some countries may not recognize this stepped-up basis and may consider the gain equal to the sale price minus the purchase price.
An irrevocable election to defer payment can be made on the mark-to-market tax of property under the following conditions:
- the election is made on a per property basis
- Form 8854 is filed
- interest is assessed for the deferment period
- the deferred tax on a specific property is due on the return covering the tax year of disposition
- adequate security, such as a bond, is posted
- the taxpayer waives any right under any US treaty that would prevent either the assessment or the collection of the mark-to-market tax
However, the payment due date of the deferred tax cannot extend beyond the earlier of when the posted security becomes inadequate or the due date of the return after the taxpayer dies.
However, the mark-to-market tax does not apply to:
- eligible deferred compensation or an interest in a nongrantor trust, since it will be subject to 30% withholding at the source;
- eligible deferred compensation, since it is valued at its present value as of the expatriation date;
- certain tax-deferred accounts, since the entire amounts in the accounts are treated as being distributed right before the expatriation date.
Eligible deferred compensation is usually not subject to the mark-to-market tax because there is a 30% tax withholding requirement by US payers or foreign payers who elected to be subject to the US withholding rules. The covered expatriate must file Form W-8CE, Notice of Expatriation and Waiver of Treaty Benefits with the payer — not the IRS — by the earlier of the day before the 1st distribution that falls either on or after the expatriation date or 30 days after the expatriation date.
However, tax withholding does not apply to services performed outside the United States if the taxpayer was not a US citizen or permanent resident at the time.
Ineligible deferred compensation is treated as having been distributed to the covered expatriate at its present value on the day before expatriation. The employer paying the ineligible deferred compensation can report the present value of the individual's accrued benefits within 60 days of receiving Form W-8 CE.
Tax-deferred accounts, including individual retirement plans, qualified tuition programs, Coverdell education savings accounts, health savings accounts and Archers medical savings accounts, are taxed according to their present value as if all the funds were distributed on the day before expatriation.
Distributions from non-grantor trusts to covered expatriates are subject to a 30% withholding tax.
An Inheritance from an Expatriate May Be Taxable to the Recipient
The US does not usually tax inheritances, but if an expatriate did not comply with all the tax rules, then an inheritance received by a US citizen or long-term resident from an expatriate will be subject to a special transfer tax assessed on the fair market value of the property minus the gift tax annual exclusion. This tax rate equals the highest estate tax rate, currently 40%, for which the donee will be responsible for paying.