As a result of the increasingly burdensome international tax and regulatory regime in the United States (see “IRS Eyeing International Taxpayers”), many more U.S. citizens and permanent residents are considering renouncing their citizenship or relinquishing their green cards than did so in the past. According to The Wall Street Journal, more than 500 people gave up their U.S. citizenship or permanent residency in the fourth quarter of 2009; more than double the number of expatriates in all of 2008. If you are considering giving up your U.S. citizenship or green card, you should be aware that there may be U.S. “exit tax” consequences.
In June 2008, Congress enacted the so-called “exit tax” provisions under Internal Revenue Code Section 877A, which applies to certain U.S. citizens and U.S. “long-term residents” who relinquish their U.S. citizenship or U.S. green card. A long-term resident is an individual who has held a green card in at least 8 of the prior 15 years.
The exit tax rules apply to individuals who are considered “covered expatriates.” For an individual who gives up his or her citizenship or green card to qualify as a covered expatriate, one of the following must also apply:
- The individual’s annual net income tax liability for the prior five years was greater than $145,000 (2010 amount), or
- The individual’s net worth (including the present value of any pension) on his expatriation date is $2,000,000 or more or
- The individual fails to certify that he or she has met U.S. tax law requirements for the prior five-year period.
A covered expatriate is required to calculate the gain on all of his or her assets as if those assets were sold on the day before expatriation, and pay an exit tax on the gain above a certain exclusion amount ($627,000 in 2010).
Current Taxation of Deferred Compensation Items
The exit tax rules provide that “deferred compensation items,” such as pensions, are subject to their own special rules.
If the deferred compensation item is an “eligible deferred compensation item,” it is not subject to the exit tax until it is actually distributed. To qualify as an “eligible deferred compensation item,” the pension payments must be made by a U.S. payor, and 30 percent tax must be withheld on the payment.
If the payor is a non-U.S. person, and does not elect to be treated as a U.S. payor, then the deferred compensation is treated as “ineligible deferred compensation.” In this case, the covered expatriate is treated as having received the present value of his or her pension on the day before the expatriation date. This amount must be reported as income on the covered expatriate’s income tax return for the year of expatriation.
The deferred compensation rules under the exit tax provisions are particularly problematic for employees of international organizations. It seems unlikely that an international organization that is exempt from U.S. income tax laws would elect to be treated as a U.S. person for purposes of withholding tax on pension distributions. If the international organization does not elect to be a U.S. payor, then any employee who qualifies as a covered expatriate will be subject to tax on the entire taxable portion of the present value of his or her pension in the year of expatriation.
Effects on U.S. Gift and Estate Taxes
The exit tax regime may also affect a covered expatriate’s gift and estate taxes. In theory, the U.S. estate tax is imposed on the transfer of the estate of every citizen or resident of the United States. There is a unified credit against the tentative tax, which, prior to 2010, effectively eliminated any tax on the first $3,500,000 of the estate. The estate tax was repealed for 2010, but will reappear in 2011 with a top rate of 60 percent and an applicable exclusion amount of only $1,000,000, unless Congress acts before then.
The general U.S. estate tax regime is not applicable to covered expatriates; instead, a tax is imposed on U.S. citizens or residents who receive a gift or bequest from a covered expatriate. The tax could be as high as 45 percent of the value of the gift or bequest. The tax is imposed only to the extent the recipient receives covered gifts and bequests during the calendar year valued in excess of the annual gift tax exclusion, which is $13,000 in 2010. The tax is reduced by any foreign gift or estate tax paid on such gift or bequest.
While tax considerations are only one factor in a green card holder’s decision to give up U.S. permanent residence, they are becoming an increasingly large factor. In addition, the exit tax rules are extremely complex, and each individual’s specific facts and circumstances must be analyzed. If you are considering expatriation, please contact us for a consultation.
This newsletter is for informational purposes only. It should not be constituted as tax, legal, or investment advice. Information has been gathered from sources believed to be reliable, but individual situations can vary and you should consult with your investment, accounting and/or tax professional.
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE WOLF GROUP TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.