A near-record number of U.S. citizens and green card holders expatriated in calendar year 2017—5,133 as reported by the IRS—and this list is widely considered to undercount the true number of expatriates.
In fact, since 2010, when Congress passed the Foreign Account Tax Compliance Act (FATCA), the number of expatriations has risen steadily each year.
Now, the recent passage of the Tax Cuts and Jobs Act (TCJA) may ease the way for more potential expatriates to remove themselves from the U.S. tax net without subjecting themselves to the dreaded U.S. “Exit Tax.”
U.S. citizens and green card holders who live abroad or have international financial interests have become frustrated with the increasingly onerous U.S. tax and reporting regime. In addition to reporting their worldwide income to the IRS each year, these individuals must also report detailed information about their non-U.S. financial assets, businesses, and other financial transactions.
Many non-U.S. financial institutions stopped accepting U.S. persons as clients due to the complexity and burden of FATCA before it even came into effect. Foreign business partners have declined or withdrawn from business opportunities with U.S. partners to avoid the heavy tax and reporting requirements levied on Americans abroad.
The high financial and mental costs of complying with the U.S. tax and reporting system have driven many U.S. citizens to renounce their citizenship, and many U.S. green card holders to relinquish their green cards. While this is often not an easy decision for a number of non-tax reasons, the difficulty is compounded by the U.S. Exit Tax regime.
Individuals who may wish to relinquish their citizenship or green card may hesitate to do so for fear of being caught in the Exit Tax net, which is designed to extract one last pound of flesh from those who expatriate.
When Does the Exit Tax Apply?
Generally, the U.S. Exit Tax may be imposed on U.S. citizens who relinquish their citizenship or “long-term residents” who give up their green cards. A long-term resident is someone who held a green card in 8 of the last 15 years.
In addition to giving up their citizenship or green card, individuals must also meet one of the following parameters:
- 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’s annual net income tax liability for the 5 years prior to expatriation exceeds a certain threshold ($165,000 for 2018), or
- The individual fails to certify on Form 8854 that he has met U.S. tax law requirements for the prior 5-year period.
An individual who expatriates and meets one of the above tests is considered a “covered expatriate” subject to the Exit Tax. A covered expatriate must calculate the taxable gain on all worldwide assets as if those assets were sold on the day before expatriation and pay the Exit Tax on the gain above a certain exclusion amount ($713,000 for 2018).
In addition, foreign pensions, individual retirement accounts, and certain other tax-advantaged accounts are treated as having been fully distributed the day before expatriation.
Becoming a covered expatriate while holding assets with significant built-in gains or owning foreign pensions or other deferred compensation can be extremely costly.
What Planning Can Be Done To (Legally) Avoid the Exit Tax?
There are a number of ways that individuals who wish to expatriate, but who may be considered covered expatriates if they do so, can avoid paying the Exit Tax. A full review of these possibilities is beyond the scope of this writing, but they can involve the following:
- Planning to fail the “holding a green card in 8 years in the last 15 years” test
- Planning to fall under the $2,000,000 net worth threshold
- Planning to fall under the $165,000 tax liability threshold
- Planning to come into full U.S. tax compliance for the past 5 years
Depending on the individual’s circumstances, he may need to use one or more of these planning techniques to avoid paying the Exit Tax. One of the most common planning techniques is taking appropriate steps to fall under the $2,000,000 net worth threshold. Recent U.S. tax law changes under TCJA have provided additional opportunities for this type of planning.
What New Opportunities Does Tax Reform Provide for Potential Expatriates?
TCJA presented several new opportunities for individuals who were considering expatriating to do so without running into the Exit Tax.
First, in order to move toward a territorial system of corporate tax, TCJA imposed a one-time “Repatriation Tax” on U.S. shareholders of certain foreign corporations with accumulated earnings.
Any U.S. person who owns (or is deemed to own, through complicated attribution rules) 10% or more of a foreign corporation that is either (1) a controlled foreign corporation majority owned by U.S. persons, or (2) owned partially by a U.S. corporation may be subject to the Repatriation Tax.
The tax is calculated on the shareholder’s pro rata share of certain retained earnings of the corporation that have been accumulated from 1986 through either November 2, 2017, or December 31, 2017. The tax will be charged at a rate of 15.5% on earnings attributed to cash and 8% on earnings attributed to other assets.
While the Repatriation Tax is yet another example of the complicated and expensive impact of the U.S. tax system on taxpayers with international interests, the silver lining is that it does provide an opening for certain U.S. owners of foreign businesses to expatriate without becoming subject to the Exit Tax.
If a U.S. person is living abroad and owns a successful business, then he is likely familiar with the complex U.S. reporting requirements. The value of his business may well drive his net worth over the $2,000,000 net worth threshold. However, depending on the retained earnings of the business, the deemed Repatriation Tax that he is required to pay in 2018 may drop his net worth close to, or below, the $2,000,000 threshold, allowing him to expatriate without becoming subject to Exit Tax.
The second potential opportunity provided by TCJA comes in the form of increased gift and estate tax exemptions. TCJA doubled the gift and estate tax lifetime exemption for U.S. persons to $11,180,000. This frees up many high-net-worth individuals to use a gifting strategy to reduce their net worth below the $2,000,000 threshold.
Prior to TCJA, a U.S. person could only gift a maximum of $5,490,000 in assets before becoming subject to U.S. gift tax. This limited the ability of many high-net-worth individuals to use gifting strategies to avoid the Exit Tax, as they would have had to pay U.S. gift tax at rates up to 40% instead. It was impossible for many taxpayers to use gifting to avoid the Exit Tax.
With the new higher exemptions, many individuals who previously would have been stuck paying either the gift tax or the Exit Tax may now be able to avoid both.
Married couples can gift up to $22,360,000 to get below the $2,000,000 Exit Tax threshold before paying any gift tax. A potential expatriate only has to include the value of his share of jointly owned assets in determining whether he meets the $2,000,000 threshold, providing even more room to get under the threshold, especially in community property situations.
The combination of the Repatriation Tax and the increased gift and estate tax exemption makes now a good time for many U.S. citizens and green card holders to expatriate, if they so choose.
These individuals may have a limited window in which to take advantage of the opportunities provided by the TCJA. The increased gift and estate tax exemption is set to sunset in 2025, so the increased gifting strategy has an expiration date.
In addition, if the Democrats win the White House and Congress in 2020, it is possible that the increased exemption will not even make it until 2025. Therefore, U.S. citizens and green card holders who are thinking about relinquishing their citizenship or green cards should engage experienced U.S. tax professionals to begin appropriate planning for their expatriation.
 83 FR 5830.
 Wilkinson, T. L. (2011, March 9). Private Banks Show U.S. Clients the Door. Retrieved from www.efinancialnews.com
 Internal Revenue Code 877A.
 IRC Section 877(e)(2).
 IRC Section 877(a)(2)(B).
 IRC Section 877(a)(2)(A).
 IRC Section 877(a)(2)(C).
 IRC Section 877A(a)(3) and Revenue Procedure 2017-58.
 IRC Section 965.
 IRC Section 2010(c)(3)(C).
 IRC Section 2502(a).