The Internal Revenue Code imposes a special alternative tax regime on U.S. citizens who renounce their citizenship. The Internal Revenue Code provides for a deemed sale of a covered expatriate’s worldwide assets on the day before the renunciation of U.S. citizenship. See section 877A. Additionally, there is a tax on future gifts or bequests made to a U.S. citizen or resident.
In short, renouncing U.S. citizenship carries with it an expensive price tag, and individuals who are considering expatriations should consider the substantial tax burdens associated with this action. Since the tax applies to an individual’s world-wide assets, the expatriation tax on high net worth individuals can make it prohibitive for certain individuals to expatriate. But for certain individuals, expatriation can be the right move.
The expatriation tax applies to an individual who is considered a covered expatriate. A covered expatriate includes any U.S. citizen who relinquishes citizenship, if the individual:
- Has an average annual net income tax liability for the five proceeding years ending before expatriation that exceeds $161,000 for 2016 ($162,000 for 2017);
- Has a net worth of $2 million or more on the expatriation date; or
- Fails to certify under penalties of perjury that he or she has complied with all U.S. tax obligations for the proceeding five years or fails to submit evidence of compliance required by the IRS on Form 8854. See Section 877A; Notice 2009-85; Rev. Proc. 2015-53; Rev. Proc. 2016-55.
Calculation of Expatriation Tax
An individual who is a covered expatriate is subject to a mark-to-market tax regime under which the individual is taxed on the unrealized gain on his or her property to the extent it exceeds $693,000 for 2016 ($699,000 for 2017). See Section 877A; IRS Notice 2009-85; Rev. Proc. 2015-53; Rev. Proc. 2016-55. For this purpose, a covered expatriate is considered to own any interest in property that would generally be taxable as part of her gross estate for federal estate tax purposes if the individual died on the day before the expatriation date.
In addition to the other requirements, a covered expatriate must file an information return on Form 8854 in each tax year the individual is subject to the mark-to-market tax. See Section 6039G; Notice 2009-85. The return is also to be used to provide notice that the individual has relinquished his or her U.S. citizenship. Form 8854 and the instructions explain how the expatriation tax is calculated and what information is required. The form requires a substantial amount of financial information to properly calculate the expatriation tax and can be administratively burdensome to complete. See Form 8854 for further details.
Individuals who are considering expatriation should contact competent tax counsel, who can evaluate the case, explain the options and come up with a solution.