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Expatriation – The Tax Aspects of Giving Up U.S. Citizenship

01/12/2014


Are you considering giving up your U.S. citizenship? Be careful. It’s not just that the costs of expatriating have increased, there are some nasty surprises for the unwary.

When a U.S. citizen ceases to be one, from a tax perspective, they become an ‘expatriate’. This is also true for some people who relinquish their ‘green cards’. Being an expatriate is no big deal. However, there is a subcategory, called ‘covered expatriate’, which entails several adverse consequences.

Who is a covered expatriate?
You are a covered expatriate if you meet even one of the following three tests:
1. At the time of expatriation, you are worth more than US$2M (this amount is not indexed for inflation);

2. Your average U.S. tax liability, for the five years preceding the year of expatriation, is more than $159,000 (2015 - indexed); or,

3. You do not certify you are fully compliant with your U.S. tax obligations:
• This means both filing and payment (tax, interest and penalties);
• It does not include the Foreign Bank Account Report (however, there are separate penalties for failure to complete these);
• The certification does not need to be made at the time of expatriation - it is due with the tax return for that year (which can be filed as late as December 15 of the following year).

Exemptions to tests #1 and #2
Some people don't have to worry about #1 and #2:
1. An individual born a dual citizen who :
• Is a resident of that other country at the time of expatriation; and,
• Has been a resident of the U.S. for 10 or fewer years of the last 15

2. An individual who relinquishes citizenship prior to age 18 and a 1/2 and
• Has been a resident of the U.S. for no more than 10 tax years

What are the consequences of being a covered expatriate?
There are a number of adverse consequences, among them:
1. A deemed disposition of substantially all assets immediately before expatriation
• Tax is applied to the deemed gains over $690,000 (2015 - indexed)
• Since there is no actual disposition, there is likely no Canadian tax, but there will be when the assets are sold. This timing difference can create double taxation.
• The U.S. principal residence exemption does not apply.
• The U.S. capital gains tax rate goes up to 20%.
• It is possible that an additional 3.8% Net Investment Income Tax applies in addition to the 20% tax.

2. Immediate income recognition of many types of assets, such as non-U.S. pension plan entitlements

3. 30% tax on certain types of deferred compensation received after expatriation
• U.S. IRA and pension payments, for example

4. 30% tax on distributions from certain types of trusts received after expatriation
• These are ‘non-grantor’ trusts; most non-U.S. trusts fall into this category
• Surprisingly, this tax applies to non-U.S. trusts as well.

5. 40% excise tax on gifts and bequests to U.S. persons after expatriation
• This is a replacement for gift and estate tax, but it is more onerous, because there is no equivalent to the $5.43M (2015 – indexed) effective exclusion

6. Requirement to file form 8854 (Expatriation Information Statement) each year in certain circumstances
• The penalty for failing to file is $10,000

7. Requirement to provide form W-8CE (Notice of Expatriation) to certain payors of income after expatriation
• This is to assist with the withholding described in #3 and #4, above

Can you avoid being a covered expatriate?

As you can see, it is desirable to avoid ‘covered expatriate’ status. For a Canadian resident, usually all that is necessary is to file 5 years back returns under the Streamlined Foreign Offshore Procedure (plus a return for the current year). Sometimes more sophisticated planning is necessary.

The important message is that you need to plan in advance. You don’t want to fall into this trap unaware, because it is virtually impossible to get out afterward.

More details are available in my full-length article: Expatriation - the American's Tax Experience in Canada.